Alternative Assets 101

Alternative assets are not found in standard investment portfolios. Examples of alternatives include art, precious metals, wine, coins and other collectibles. More traditional alternative investments include private equities, hedge funds, managed futures, real estate, commodities, and derivative contracts. These alternative assets are usually less liquid than traditional investments such as stocks, bonds and cash, and thus, have longer investment terms — usually over 12 months.

Most alternative assets are usually held by institutional investors or accredited high net worth individuals due to limited regulations and their complex nature. Alternative investments usually have a low correlation to traditional markets, which make them a preferred avenue for portfolio diversification. Therefore, large institutional funds allocate approximately 10% of their portfolio to alternative assets.

Alternative investments typically have higher upfront fees, but their transaction costs are usually lower than traditional assets due to lower levels of turnover. Another upside to investing in alternative assets is lower capital gains tax as investments are usually held for longer than 12 months.

Source: Bloomberg

Take art funds as an example. Art funds bear similarities to REITs, real estate investment trusts — both are physical assets that have relative illiquidity in comparison to traditional assets. Most art funds adopt an asset holding strategy, with an assumption that assets will appreciate over time. Some see positive returns, with a sizeable fraction receiving an approximate return of 30% year-on-year. The main difference between REITs and art funds are that REITs can be improved with investment while art assets must be carefully preserved and stored. Furthermore, art funds do not pay dividends, with payouts received when the asset is sold at a higher value.

The main similarity between REITs and art funds is their quantifiable investment strategy. For a house, physical attributes are more intuitive — such as size, build year, comparables and amenities. For art funds, companies like Arthena use hedonistic regressions using at least thirty statistically significant regression parameters that can be used to predict the future value of an art work.

The increasing interest in investing in alternative assets is due to the growth in number of high net worth individuals. Between 2008 and 2014, growth in alternative assets under management by asset class has nearly doubled — as sign of an increasing demand to diversify portfolios in alternative assets.