Alternative assets have moved from the sidelines to become a critical part of sophisticated portfolios.
This shift is in large part about the strong diversification benefits that alts can bring to portfolios. It’s also about seizing opportunities that traditional markets sometimes overlook.
Evolution and Current Landscape of Alternative Assets in Contemporary Portfolios
Once reserved for only the largest institutional investors, alternative assets have carved out a significant niche thanks to pivotal market changes and regulatory adjustments.
Specifically, the JOBS Act of 2012 opened the floodgates for broader investor access to these markets. The JOBS Act eased startups’ pathway to IPOs, which are considered to be the most lucrative form of VC exit.
The act also allowed for the registration of venture exchanges with the SEC, creating a space built to meet the needs of small and emerging companies where their securities can trade.
This helped address the lack of resale and liquidity options for crowdfunding investors.
Fast forward to today, and we’re seeing an unprecedented integration of assets like private equity, hedge funds, and tangible assets into the portfolios of the professional wealth managers and investors.
The numbers speak volumes.
Data from Preqin shows that by the close of 2015, total alternative assets under management (AUM) were valued at $7.23 trillion. Fast forward to the end of 2021, and this number nearly doubled to $13.32 trillion.
Projections indicate that alternative asset AUM will continue its upward trend, increasing by approximately 11.7% to reach a remarkable $23 trillion by the year 2026.
Analyzing Performance Beyond Traditional Benchmarks
The allure of alternative assets isn’t just in their novelty but in their performance.
Comparing the Sharpe ratio, a measure of risk-adjusted return, of private equity and hedge funds against traditional stocks and bonds reveals an interesting story.
Hedge funds have outperformed stocks and bonds on a risk-adjusted basis, as measured by the Sharpe ratio.However, the Sharpe ratio can overstate hedge fund performance thanks to issues like serial correlation in returns.
The Sharpe ratio does have limitations, especially for more volatile investments like hedge funds. Other risk-adjusted metrics like the Sortino ratio, which focuses on downside risk, might provide a more balanced view
Even so, the Cambridge Associates U.S. Private Equity Index has regularly outperformed the S&P 500 on a risk-adjusted basis over the past two decades. But it’s not all completely straightforward though.
Private equity returns outperformed their public market equivalents between 1994 and 2005, but the average alpha (returns exceeding benchmark) fell from 8.9% to 1.5% per annum after that as the private equity industry matured and AUM grew.
Figure 1 above shows the relative performance of private equity and VC in comparison with the S&P 500 and the Nasdaq. Infographic from Cambridge Associates.
Strategic Integration into Portfolios
Incorporating alternative assets into a portfolio requires more than a cursory nod to diversification.
It demands a strong understanding of how different assets interact under various market conditions.
Consider the case of direct real estate investment: it’s not just about adding real estate into the mix but understanding its impact on liquidity, income generation, tax implications, and correlation with other investments.
You might be interested in exploring tools like Monte Carlo simulations to forecast outcomes and manage risk proactively.
