In the latest sign that alternative investments are going mainstream, JPMorgan revised its Bitcoin target price to $130,000 at the beginning of April. More investors are aware of alternatives and interested in adding them to their portfolios. A 2020 survey by Connection Capital found that 87% of private investors surveyed were planning on maintaining or increasing their allocation to alternative investments over the next 12 months.
What is driving the interest in alternative investments? I see five main factors.
1. Many investors are tired of hair-raising market volatility.
Last year was one of record-breaking volatility. In March 2020, the 11-year bull market abruptly came to an end, and the VIX volatility index hit a record high. Although the S&P 500 ended the year up 16%, volatility remained elevated throughout 2020. The VIX spiked several more times, capping off with the presidential election in November.
This volatility was not uniform across industries. The Covid-19 pandemic led to significant volatility increases in industries like transportation, apparel, and travel and leisure, while others such as healthcare and telecom were much less impacted.
Alternative investments are generally uncorrelated with public markets, meaning that adding them to a portfolio can increase diversification and reduce overall portfolio volatility. For example, gold and silver, two of the most well-known alternatives, both hold value well and have a low correlation with stocks. Real estate can beat the market depending on location and market conditions. U.S. farmland, my specialty and the most newly accessible alternative, is uncorrelated with most major asset classes, including stocks, bonds, real estate and gold, and has a track record of maintaining value during times of volatility.
2. Equities remain expensive, and forecasted future returns look less appealing.
By many metrics, the U.S. stock market is currently expensive. All three major stock indices are at record highs, and the S&P 500’s P/E ratio, equal to the market value per share divided by earnings per share, is well above historical averages. Another popular metric known as the “Buffett Indicator,” measured as the total market cap of U.S. stocks divided by GDP, is also at an all-time high. Whether you believe this is a sign of an impending bubble or not, the stock market does seem expensive.
Many analysts also are increasingly pessimistic about future stock market returns. Charles Schwab forecasted that returns on U.S. large-cap stocks would fall to 7.1% from April 2020 through March 2030, compared to historical returns of 10.1%. Declines in U.S. small-cap stock returns are expected, as well.
This could cause long-term investors to find value elsewhere. Many alternative investments have historically provided attractive returns. For example, fine wine investments often see returns of 10%-15%. And U.S. farmland has returned an average of 11.5% per annum since 1991, according to the USDA. These options allow investors to diversify their income streams and portfolio.
3. Low interest rates are depressing returns.
The low interest rate environment has taken the wind out of the sales of many traditional safe haven assets. U.S. government bonds, the safe haven investment of choice for individual investors, are returning a yield below inflation, and many high-quality sovereign bonds from OECD countries have negative yields. What this means is investors can no longer count on a traditional 60/40 portfolio to provide healthy returns and safeguard against capital loss.
Instead, many investors are using alternative investments, such as real estate, as safe haven investments. This asset class has many of the advantages of traditional safe haven investments — including a lack of correlation to equities, lower volatility and strong performance through market cycles — while offering the potential for much better returns than highly rated sovereign bonds.
4. Investors are planning for higher inflation.
A fourth factor I see driving investor interest in alternatives is the specter of inflation. According to a survey by Bloomberg, analysts believe inflation may rise to as high as 2.9% through June 2021 and slowly taper down to around 2.2% in 2022. Although some economists, like Fed Chairman Jerome Powell, believe inflation is a short-term phenomenon, other economists worry rising inflation may be a more dangerous, longer-term problem.
Bonds, especially longer-duration bonds, fare poorly in a rising inflation environment. Instead, investors can turn to alternative investments that can act as a better store of value. Gold has long been the preferred alternative for investors concerned about inflation. Another option is U.S. farmland. Crop payments are inflation-linked, and the value of farmland is supported by its critical role in the economy and its scarcity value.
5. Technology is democratizing alternative investments.
The fifth factor driving the rise of alternative investments is technology. Institutional investors and ultra-high net worth individuals have realized for decades that alternative investments have the potential to offer returns that are equal to, if not better than, public equities. However, for individual investors, most alternatives were difficult or impossible to access due to a combination of high investment thresholds, a lack of transparency around the market for many alternatives, and the high degree of specialized knowledge required to understand and value investment opportunities. Now, technology-enabled platforms are giving individual investors access to the kinds of alternative investments that were previously only available to a select few.
Before getting into alternatives, investors should consider their goals.
Although alternative investments are typically a strong option for investors, it depends on one’s investment goals. Many of these investments require several years before an investor sees the full financial results. If you’re looking to make money fast, alternatives may not be suited for you. In addition, most are relatively illiquid compared to stocks and thus make it difficult to exit. Many alternatives are best suited for investors comfortable with and looking for a long-term investment. Lastly, some, such as farmland, are more novel investment opportunities. Companies providing access to these assets don’t have a long track record, forcing investors to place trust in them at an early stage.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.