How Did the 2008 Crash Change Alternative Investing?
2008 saw the single worst economic downturn since the Great Depression in 1929. And even to this day, fourteen years later, we’re still unraveling the many complex ways that the 2008 crash impacted the markets we now operate in.
You might be surprised to learn that the current uptick in alternative investments is related to the crisis, even though alternative investments weren’t very well-known or popular back then.
Here’s a look at the 2008 crash, alternative investing, and how the crisis drove the current market for alternative investments.
Basics of the 2008 Financial Crisis
First, it helps to understand the circumstances of the 2008 crisis.
In simple terms, the 2008 recession was the long overdue crash from many years of binging on cheap credit. The whole crisis was fueled by two things: cheap credit and lax lending standards. It went something like this.
Fannie Mae began actively targeting the subprime mortgage market back in 1999, hoping to bring more lenders closer to the American Dream of homeownership. Granted, subprime mortgages (mortgages targeted toward consumers with poor or nonexistent credit and poor or nonexistent savings) were still worth a lot of money, so lenders offered unconventional loan terms.
The most common (and most dangerous) was the adjustable-rate mortgage (ARM), which gave borrowers a far lower initial rate than they could find on traditional fixed-rate mortgages. The problem was that these loans reset after a few years, sometimes just two or three years, after which the payment amount fluctuated month-to-month but was always higher than the initial rate. And thanks to predatory lending and lax standards, many borrowers didn’t fully understand what they were signing up for.
Once the loans reset, borrowers were saddled with debt they couldn’t afford. They began to default. That was when the chain of underwritten loans began to crumble, as lenders suddenly lost millions of dollars in income.
As it became clear the markets couldn’t resolve the real estate crisis, the interbank market froze, largely due to global fear. In simple terms, global money froze in place, and central banks had to commit billions in rescue funding into the global markets as asset prices plunged and liquidity ground to a halt. In the meantime, lenders had to assess the value of trillions of dollars in toxic mortgage-backed securities sitting on their books.
And because global markets were increasingly entwined, once the U.S. faltered, the rest of the world stumbled with it.
Basics of Alternative Investments
With that in mind, let’s take a look at alternative investments.
An alternative investment is any investment that doesn’t fit into one of the three conventional investment categories (stocks, bonds, and cash). Basically, it’s an umbrella term for a huge number of investments, from fine art to real estate to gold to distressed securities to hedge funds.
However, all alternative investments have a few features in common. They all have low correlation to the stock market, as they often don’t derive their value from stock performance. They also have relatively low liquidity compared to conventional assets. They’re also much more complex than conventional assets, in part because they generally sell in small, niche markets that cater to a small group of investors.
The 2008 Crash: Alternative Investing
This brings us to the 2008 crash and alternative investing.
Picture the 2008 market. The floor dropped out from under investors—institutions and investments that were thought to be secure fell apart at lightning speed. Almost every investor on the market saw a steep drop in their asset value as a result of the crisis. Worse, financial markets now move in tandem more than ever, largely because of the 2008 crisis.
In a market like that, an investment with low stock market correlation sounds rather appealing. In fact, many investors and financial advisors learned the value of alternative investments as a result of the crisis.
The Crash and the Upsurge of Alternative Investments
Since the 2008 recession, financial analysts have noted three major trends:
- Shift from direct to indirect investing
- Shift from active to passive investing
- Shift from public to private companies
In that context, the rise of alternative investments makes perfect sense.
Investors who were already active in the market in 2008 saw almost all of their assets plummet in value. But alternative investments work differently than conventional assets—they derive value from intrinsic value, not the stock market. And unlike conventional assets, their market is completely different, which means demand may not move in tandem with the global financial market.
Investors who have come into the market since 2008 (or grew up seeing their parents lose everything in the recession) are now more cautious than previous generations. That explains the rise of passive investing (a set-it-and-forget-it mentality that eliminates the need to trust a financial advisor’s judgment) and the push for alternative investments (a safe hedge against market volatility).
The Future of Alternative Investments
The good news is that the 2008 crisis helped alternative investing—and because of rising demand, there are now more options available to average investors than ever before.
Traditionally, alternative investments were the sole purview of people who qualified for the term high net worth. These days, financial advisors now seek alternative investments for regular clients, and companies and markets have responded by making alternative investments more accessible.
In other words, while the 2008 crisis had a lot of negative effects, it actually had a positive impact on alternative investments—especially for average investors.
Smart Alternative Investments for Savvy Investors
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