In this article, Stableton gives you a short introduction into what the investment community usually refers to as Alternative Investments. Instead of trying to burden the reader with a definition, we’ll start by explaining why every investor should care at all.
Hint: it is elusive, complicated at best, but most importantly, not relevant. It does not matter whether you are a small or large investor, a professional allocator working on behalf of others, or someone who needs their hard-earned money not to be slowly consumed by bank account charges. We believe that everyone can and should make an informed decision, private investors ideally with their financial advisor, how to add Alternatives to their existing investment portfolio.
Why even care about Alternative Investments?
In the last twenty years, we have seen several crises that resulted in losses of more than 50% of capital for several asset classes. Some of us may still have vivid memories of the dotcom bubble in the early 2000s, the global financial crisis in 2008 (some may argue that it is still ongoing, but that is another topic), the European debt crisis only a few years back, and, more recently, flash crashes.
Mutual funds that invest in the assets depicted in the graph below have become a popular way to participate in the upswings of the economic cycle.
To use the musical chairs analogy: will there be a chair left for everyone?
Today, we look back at a ten-year bull run in the equity markets that was fueled by low or negative interest rates. We believe that is has made even professional investors endlessly optimistic, and some might say, reckless. It does not take a lot of expertise to look at the current high market valuations across almost all assets to suspect that the risk of a market correction, or even a full crash, has become much more likely.
According to our data, the level of automation on certain stock exchanges has reached levels of 60% and above. This is a direct result of the recent rise of automatic trading programs, which tend to sell automatically when certain thresholds are breached. In other words, should a crash occur today, the ensuing fire sale might be even more violent compared to the days when humans alone panicked about losing their shirt. This alone should make the current market scenario scarier than, say, than it already would have been ten years ago.
How to spot a bubble
One or more of the below symptoms (loosely based on a chart by UBS from the 2000s) may point to an impending bubble:
- Rapid market growth
- Cheap money
- High valuations
- Unrealistic return expectations
- Excessive leverage
- Frantic M&A activity
- Mass media coverage
- Everone’s invested and bragging their gains
By their name, Alternative Investments are labeled as an alternative to traditional mutual fund types of investments, or mainstream asset classes such as listed equities or bonds.
Venture Capital, Private Equity, Hedge Funds, and Real Assets – segments as heterogeneous as they come
Venture Capital, Private Equity, Hedge Funds, and so-called Real Assets (such as Commodities, Real Estate, Agriculture, Timber, and even Art) are often referred to as Alternatives in literature. A summary look at the naming of the sub-strategies - or segments, or sectors, another hint that not only the definition but even the classification are anything but agreed on - will quickly reveal that Alternative Investments are anything but a homogenous asset class like stocks and bonds.
Speaking of classification: as if this were not confusing enough, it is fluid within each sector. For instance, some regard Venture Capital as part of Private Equity, since it is one of the early stages of a company life-cycle (others being Growth Capital, Buyouts, and Turnarounds/Distressed).
Why the correct classification might not be particularly relevant to an investor
Another potential overlap is possible between an active Buyout (Private Equity) fund and an activist special situations, a.k.a. Event-Driven Hedge Fund. There are many more such grey areas, which only shows that the classification might not just be complicated, but arbitrary, and most importantly, not that relevant to an investor.
The relevant factor, we believe, are those properties that differentiate Alternative Investments from traditional investments, i.e., mutual funds or exchange-traded funds.
A skill-based mindset, regardless of where markets go
To avoid losses, and ensure predictable, sustainable performance, the best Alternative Investment managers are relying on a specific mindset.
A sure sign of an amateur investor is their inability to attribute their investment results properly. Inexperienced investors tend to mistake their success for skill.
Professional investors, particularly in the Alternative Investment space, will go to great lengths to eliminate the concept of luck, be it bad or good, from their toolset. This approach includes understanding all relevant factors that drive performance and separating those they can influence from those they cannot (like market risk, i.e., markets behaving unexpectedly).
Alternative Investment managers may want to reduce the impact of market risks, such as those of fluctuating stock markets and interest rates. This approach to risk reduction is in stark contrast to traditional asset managers who expose their capital (and with that, their investors) to these risks for their returns.
Once their exposure to market risks is reduced or eliminated, Alternative Investment managers can specifically pursue price inefficiencies and other dislocations, which illustrates their superior understanding of every investment case.
Looking beyond the horizon of traditional asset classes
A key characteristic of Alternative Investments is being unconstrained to look beyond traditional assets into areas such as alternative equity, market-neutral strategies, managed futures, volatility, tail-hedge, alternative lending, value-added real estate, and selected startups.
This, for example, means not being limited to investing in publicly listed blue-chip companies that everyone is tracking, and where, due to the scrutiny of millions of eyes trained at them, opportunities are infinitesimally harder to uncover.
Alternative Investments have access to a broader set of tools to achieve their objectives
To be able to apply their skill-set to an investment transaction and remove any unwanted (i.e., not manageable) risk, Alternative Investment managers often rely on a flexible toolset.
While traditional asset managers can either hold an asset or not (stay in cash), Alternative Investment managers can also “short” an asset, i.e., sell a security to repurchase it at a lower price. They might not do this to simply speculate on lower prices as is often alleged in the media, but to neutralize, for example, market, sector, or interest-rate risk they already hold through their other assets.
Using leverage to reduce risk?
With those risks reduced or eliminated, Alternative Investment managers may also employ some leverage, resulting in long and short assets temporarily exceeding overall fund assets. However, this type of leverage-taking can actually lower the overall risk compared to traditional asset managers. While the unique approach to risks and its management by Alternative Investments deserves an article on its own, let us remark that most of us have more leverage in our home mortgage than the average hedge fund employs in their daily work.
In terms of the toolset, some have used a golf analogy to explain Alternatives vs. traditional investments. While the former can play with a full set, the latter is restricted to only a few clubs. We would argue that having more tools at one’s disposal increases the chances of being successful, provided one is versed in using them.
Stableton’s approach to Alternative Investments
Stableton believes that the proper implementation of an absolute return strategy does not only entail a significantly lower risk of a significant capital loss - as there is no rigid link to a benchmark - but usually also considerably more calculable investment results.
This article barely scratches the surface. If you are interested to learn more about Alternative Investments and how to efficiently access them, please visit www.stableton.com.
About Stableton Financial AG
Stableton Financial AG is a Switzerland-based, rapidly growing financial technology company. The company’s alternative investment Fintech platform is designed to be Europe’s leading gateway for qualified investors and financial advisors seeking simplified access to absolute return and alternative investment strategies such as hedge funds, startups, alternative lending, and real estate. Stableton was founded by entrepreneurs with decades of experience across the alternative investments value chain.