How to Diversify Your Portfolio With Alternative Investments

November 30, 2021

More investors are venturing into alternative investments like real estate, art, collectibles, and venture capital funds to safeguard their portfolios against volatility. According to a 2020 survey by Connection Capital, 87% of private investors will continue to stick to or add alternative assets for the next 12 months. With an already $9.56 trillion market value by 2018, this should be the green light for you to consider bumping your portfolio from classic cars to rare art.

For a smart investor, you may want to take a step back and understand what alternative investments are all about, as well as the benefits and strategy behind investing in alternatives.

What Are Alternative Investments?

Alternative investments are not like traditional investments such as bonds, publicly traded stocks or mutual funds. They instead include assets such as real estate, commodities, fine art, antiquities, derivatives, venture capital, private equity, private debt, and hedge funds.

They offer a great way for you to diversify for great returns on investment. In addition, there is regulation backing as a means to protect investors’ portfolios. Managers or advisers to alternative investments must be regulated by the Securities and Exchange Commission (SEC).

What’s Unique About Alternative Investments?

An average investor will likely think that the term “alternative” is meant for a certain class of investors, probably high net worth. While some of these asset classes come with a high price tag, such as vintage wine, categories like real estate have been there since time immemorial.

However, putting over 80% of your money in stocks is very risky should the markets suddenly dip. Aside from the diversification factor, alternative assets have shown a strong growth trajectory in the last few years.

In the period between 2007 and 2017, private equity funds performed exponentially better compared to other alternative classes by 13.3%, and in 2020, their value increased by 5.1 %, translating to $7.4 trillion.

That aside, alternative investments are highly illiquid, which can discourage you as an investor. This means you can’t quickly get cash in exchange or sell without some significant loss in value.

The minimal regulation alternative assets are under makes investors wary of investing their money. While alternatives are subject to examination by the SEC, they’re not registered with the body, requiring you as an investor to do more research, adding to their complexity.

The Advantages of Alternatives

High net worth individuals and individual investors alike are showing a strong and growing interest in alternative assets. Ultra-wealthy investors have dedicated 50% of their portfolios to nonconventional assets, while 81% of institutional investors intend to shift their assets into alternative investments.

So, what is it about these assets that investors are willing to place a good chunk of their portfolios?

Hedge Against Inflation: With inflation rising to new highs, alternatives can be used to hedge against these rising prices. Commodities such as energy and industrial metals tend to be correlated to inflation indices such as the consumer price index, making them solid options for strong portfolio diversification. As things continue after the surge of commodity prices due to the COVID-19 pandemic, savvy investors need to look into ways to cover themselves against inflationary effects.

Uncorrelated to the Market: Another reason investors are drawn to alternative investments is portfolio diversification and great returns. Typically, the performance of alternative assets is not correlated to stocks, which act as a financial cushion against fluctuating prices in the market. For example, gold offers a strong hedge against inflation, has a minimal barrier to entry, and is more liquid compared to other alternative assets like real estate. Another good investment is contemporary art, which has maintained an annual return of 14% for 25 years up to December 2020.

Passive Investment: Wealth experts recommend having a passive income to increase your revenue over time. Real estate offers a good passive investment alternative by providing steady rental income. Despite the pandemic, buying a rental property is a safe investment option, as the numbers of buyers and investors have increased.

How to Invest in Alternatives

As with any investment, it’s good to strike a balance between risk and return. Experts advise putting between 10%-20% of your assets into alternatives for the most impact. Of course, this also largely depends on your investment objectives as an individual investor.

You also need to consider factors such as the time horizon, which is the length of time you hold an asset. Real estate, on average, has a buying and holding period of between 8-10 years, which offers a moderate hedge against market fluctuation. Hedge funds span from shorter to longer periods, with the potential for long term profitable returns.

You also need to study the markets and industries you plan to invest in. If you want to invest in private equity or debt, choose private companies that are the right fit for your portfolio.

Alternative investments are growing in popularity because they can offer diversification to your portfolio, protecting you from stock market risk while opening up new growth opportunities that are uncorrelated to the wider market.

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.