The World of Alternative Investments: What’s On The Map

Alternative investments are getting more attention than ever before due to erratic markets, low interest rates on bonds, and the ability for a broader variety of investors to participate in this asset class for the first time.

Whether you’re new to alternative investing or merely want to learn more about the state of the sector, there’s plenty of information to sift through. We’ll help make sense of alternative investments, what you need to know about the world of alternative investment opportunities, how alts perform versus other traditional asset classes, and more.

The more you look at the map of alternative investments, the more there is to discover. The well-trodden path of commodities and real estate aren’t the only places worth exploring—nor are they the only place to invest where you can position yourself for long-term growth.

What are Alternative Investments?

Alternative investments are a broad classification for investments that aren’t traded publicly, such as stocks, investment funds, or government bonds. They’re far from a monolith: in fact, the world of alternatives is much broader than that of stocks or even funds. Even in spite of the proliferation of index, mutual, money market, or fund-of-funds now available to investors, the alternative investing arena is still more diverse in terms of distinct opportunities and asset types.

The world of alternative investments isn’t new: in fact, the Transcontinental Railroad is considered the first infrastructure alternative investment, and the establishment of the Bessemer Trust in 1907 to be the first family office. They, like many investment types, have evolved over time to include new and unique forms.

Some alternative investments, such as those in real assets like gold and commodities, have long attracted investors of different stripes. As the markets became more complex at the dawn of the internet age, so too did the number of alternative investments available to investors. In 2010, alternative assets under management clocked in at $4.1 trillion. This number hit $10.8 trillion in 2019, and is forecasted to skyrocket to $17.2 trillion by 2025.

*2020 figure is annualized based on data from October 2020; 2021-2025 via Preqin forecasted numbers

Source: Preqin

The reasons for skyrocketing demand vary. Investors are increasingly sophisticated, and there’s an increasing number of investors. This means there’s a wider pipeline of people entering the financial markets as well as a broadening amount of savvy investors who understand the potential of alternatives in their portfolios.

In other cases, the surge in alternatives could be due to the relatively muted performance we’ve seen during the past decade on Wall Street. Compare the AUM of mutual funds to that of alternatives, for example:

Source: Preqin, Statista

Although U.S.-based mutual funds may have more AUM than alternatives, alternatives are gaining steam in terms of investor interest. They’ve outpaced mutual fund growth trends since around 2017 and mutual funds have only just shown signs of catching up within the last two years.

Types of Alternative Investments Broken Down

There are a variety of alternative investment types, each with its own pros and cons. Some attempt to maximize returns at the expense of stability, others are designed for slow and steady growth. Others still are designed to offer a long-term hedge against inflation and stock market volatility.

Real assets are perhaps the best known alternatives around. That’s because real assets are tangible pieces of property: your house, for example. Whenever you own something that’s designed to appreciate over time and is a physical object, you have an investment in a real asset. Real estate is perhaps the most common example of a real asset: if you own your home, a rental property, or a parcel of land, you’re invested in a real asset. Farmland in specific has recently become one of the most talked about real assets and segments of real estate due to its compelling financial characteristics and long-term impact potential; while technically the oldest asset class in the books, it's one of the newer alts in terms of its increased accessibility.

Private equity is another common alternative investment. Think of private equity as a private way for businesses and entrepreneurs to invest in companies (or buy them out). Private equity firms typically assemble money from investors and use it to finance certain initiatives, such as buying part or all of an enterprise, with the intent to generate returns for investors. Private equity players typically consist of ultra high net worth individuals and institutional investors.

Hedge funds are commonly known, if not entirely understood, among investors. Hedge funds pool together resources from several investors who typically need to invest at least $100,000 to $1 million dollars to participate. From there, the fund managers make investment decisions designed to maximize return while minimizing risk. Successful hedge funds beat market returns by double-digits, but can also come with high management costs.

Private credit makes up the last of the big four alternative asset classes. With private credit, investors lend money to businesses or individuals, rather than a bank or financial institution providing the loan. Investors can make significant returns through private credit investments, which is why it’s become an area of significant growth and new investment dollars within the world of alternatives.

Alternative Investment Performance versus Traditional Investments

Many investors are interested in alternative investments because of the market-beating returns they may generate. They tend to have low correlation with market moves, have demonstrated significant returns in recent years, and may give investors another means to generate value while interest rates remain at near-zero.

“Private markets are a core part of the investment landscape, and have seen an incredible rate of growth in size and influence in recent years,” says David Lowery, Prequin’s Head of Research Insights. “The fundamentals are strong: alternatives funds keep offering investors strong, uncorrelated long-term returns, even through the sustained low-interest rate environment and volatile market cycles of recent years.”

The numbers help tell the story of why alternatives outperform traditional investments. Here’s a simple example: the price of gold versus the Dow Jones Industrial Average’s yearly close.

An investment in gold, particularly within the last five years, would grow at a faster clip than the DJIA. Granted, these are two different kinds of investment opportunities, comparing growth helps shed light on just how critical alternatives have become in a well-rounded portfolio.

Why Investors are Turning to Alternatives

Alternative investments have become a hot topic within the world of investing. Even small-time individual investors know a thing or two about alternatives these days, be it due to the rise of cryptocurrency or the popularization of derivatives trading, among two of many other headline-grabbing phenomena.

From a practical perspective, alternative investments are one of the few areas in which investors can maximize their money. For example, the private credit space generated returns that ranged from 8.1% IRR to %14 IRR in 2018, which rivals the stock market’s 9.2% IRR over a 10 year period. Investors who are committed to generate market-beating returns need to get creative; the world of alternative assets help them do so.

Other investors are looking to fill a hole that bonds once occupied in a well-balanced portfolio. Treasury bond rates have sat near 0% for years, which makes them an unappealing option for those who want to generate real return on interest. Commodities, on the other hand, have stayed steady or have grown during the same period.

Farmland is a great example: the average price of an acre of farmland has grown significantly, on average, since the mid-1980s. This is compared to the four recessions we’ve experienced since the early 1990s, meaning that farmland has proven itself to maintain value in spite of market headwinds.

The broadening world of alternatives in and of itself is enough to stoke the curiosity of more investors. Online investing platforms make it easy to get into the world of alternatives: plus, many make it less expensive or time-intensive to do so. Whether that means trading derivatives through apps or investing in farmland through FarmTogether, the new era of alternative investing platforms has helped the overall alts market grow—all by democratizing the ways in which people can participate.

Broadening the Borders and Generating Value

The world of alternative investments has grown as technology enables more asset classes to reach the masses. A broader number of investors are now able to participate as well, with the threshold for becoming a qualified investor now lower than it has been in the past. These two phenomena combined create a unique, shifting, and most of all expanding, map of the growing world of alternatives.