A Fundamental Investing Approach to Alternative Investments

February 9, 2022

What do you do when you’re working with an asset that’s difficult to value? Even if it’s a potentially strong investment, you face serious challenges if you can’t assess and verify the asset’s strengths before you sink your money into it.

Unfortunately, it’s a problem across all alternative investments. But the good news is that you’re not stuck with guesswork. In fact, there are well-established methods to assess the strengths of an investment.

Here’s a look at fundamental investing, alternative investments, and how you can take a smarter approach to valuing your alternative assets.

What is Fundamental Analysis?

Fundamental investing is a technique built on fundamental analysis.

Fundamental analysis is a method of measuring a security’s intrinsic value (the objective value of an asset or security) by examining relevant external factors that drive value, including macroeconomic and microeconomic factors. A fundamental analyst understands that almost anything can affect a security’s potential value, and so they dedicate a great deal of effort to understanding what the security’s true fair market value is.

If the fair market value is higher than the market price, the asset is undervalued. Conversely, if the fair market value is lower than the market price, the asset is overvalued. An undervalued investment might prove to be worthwhile, while an overvalued investment isn’t worth the trouble.

Components of Fundamental Analysis

Fundamental analysis consists of three components:

  1. Company analysis
  2. Industry analysis
  3. Economic analysis

In order to perform true fundamental analysis, you need a deep knowledge of finance, accounting, and economics—you’ll get down in the weeds of all three. For example, you’ll spend a lot of quality time with a company’s quarterly financial reports, but you’ll also spend a lot of time analyzing economic trends and assessing how they play out for the asset in question. It’s an extremely comprehensive breakdown of the asset as well as the art and science of fitting puzzle pieces together.

Whether you’re a professional analyst or a novice investor, fundamental analysis relies primarily on public data.

Top-Down vs. Bottom-Up

Fundamental analysis can be either top-down or bottom-up.

In a top-down approach, the investor looks at the big picture and then zeroes down on the finer details. For example, an analyst might look at major macroeconomic factors indicating overall economic health, such as the GDP, inflation, and interest.

In this case, the investor would try to figure out the overall direction of the economy and identify sectors with the strongest investment opportunities. Once they identify potentially strong sectors, they narrow down their options to a few strong opportunities within that sector, such as companies that are performing quite well or leading the industry. At that point, the investor selects securities from the most promising options, such as stocks in high-performing companies.

In a bottom-up approach, an investor works in the opposite direction. Instead of starting with the big picture, the investor jumps straight into analysis of individual stocks. In this case, they focus on microeconomic factors, such as the company’s performance. The focus here is on the company’s operations and assessing its overall health, based on the assumption that individual stocks can perform better than the industry overall.

Qualitative vs. Quantitative

Regardless of whether you take a top-down or bottom-up approach, fundamental analysis relies on two types of fundamental factors: quantitative and qualitative.

Quantitative factors are any relevant information that can be shown as numbers, while qualitative factors refer to the nature of something.

You can find quantitative factors in the company balance sheet and financial statements. In fact, most relevant quantitative indicators can be found in a company’s financial statements—it’s the hard numbers you can find in revenue, profits, assets, and other key factors. If you’re taking a top-down approach, your quantitative factors would be hard economic data.

Qualitative factors can’t be found on the company balance sheet—in fact, they’re usually things that you can’t see but you can feel. Qualitative analysis covers anything from the strength of the company’s brand image to its management style to its current patents.

Neither quantitative nor qualitative analysis is inherently better. Most analysts and investors look at both of them side-by-side for a comprehensive picture.

Why Fundamental Analysis is Critical for Alternative Investments

Up until this point, we’ve talked almost exclusively about companies and stocks. The truth is, fundamental analysis focuses heavily on stocks. But it’s just as useful—if not more so—in assessing the fair market value of alternative investments.

Alternative investments face a unique challenge that other assets don’t: they’re difficult to value, in part because they have very low stock market correlation and they’re often highly individualized. Comparing a Renoir and a Rothko is like comparing apples and oranges. Even if you compared a Renoir to another Renoir, it wouldn’t do you much good—the works themselves are too unique.

Fundamental analysis (and a fundamental investing approach) allows you to stop looking at alternative investments in a vacuum. The whole investment technique requires you to actively study the context surrounding the investment in question.

Fundamental Investing: Alternative Investment Approach

The key to fundamental investing is context. For alternative investments, that means it’s time to do your homework.

An alternative asset may not come with a quarterly financial statement, but there are certainly external factors that can be used as value indicators. A piece of art, for example, fluctuates in price based on the artist’s auction record, upcoming shows, and shifting demand for their work.

So, to get started with fundamental investing in alternatives, you have to identify what those context clues are. Then, you have to do your homework to understand what they mean.

A Smarter Way to Invest in Alternatives

With fundamental investing, alternative investments don’t have to be a mystery. And with the right tools and partners, you can get smart about your alternative assets.

Here at Masterworks, we do a lot of the homework for you (with some help from our expert research partners at Citi Bank and Bank of America) so that we can provide shares in securitized multi-million-dollar art from high-growth artist markets with the highest potential risk-adjusted returns. We handle the buying and selling process, too, so all you have to do is read up on shares that work for your strategy and collect dividends when we make a sale.

Ready to get started? Fill out your membership application today to learn more.

Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.