Understanding Alternative Investment Assets in Detail

Let’s start this with some trivia.

By 2025, the alternative investments market is on track to hit a staggering $21.1 trillion, making up about 15% of global assets under management.

So naturally, investors are increasingly setting their sights on private markets, moving beyond the traditional public equity and debt. It’s no longer about stocks and bonds; alternative investments, like private equity, private debt & real estate are now the talk of the town.

Now, let’s take a page from Blackstone’s playbook to understand this shift. Picture this: Circa 2007, Blackstone — the bigwig of alternative investments — makes a bold move by acquiring Hilton Hotels. Price tag? A cool $26 billion. But this wasn’t just about dollars and cents. Hilton, at that time, was struggling with the heavy weight of debt and operational inefficiency. And to thicken the plot, this deal went down right before the 2008 financial crash – a time when others were battening down the hatches.

But here’s where Blackstone breaks from the pack. When the market trembled, they didn’t bail out. They rolled up their sleeves instead and got to work. Step one: overhaul Hilton’s debt. They didn’t just lighten the load; they gave Hilton the muscle to stand tall amidst the crisis. Step two: pump money into Hilton’s growth – They added over a thousand hotels, spruced up the existing ones, and rolled out shiny new brands, all of which put Hilton back on the global map in a big way.

Fast forward to 2013, Hilton’s IPO hit the ground running – a blockbuster in the hospitality sector. By the time Blackstone bid adieu to Hilton in 2018, they had not just doubled but more than doubled the hotel chain’s value, turning this deal into a textbook example of private equity prowess.

Needless to say, Blackstone investors realised handsome returns from the deal. Then again, the Blackstone-Hilton collaboration is but a small glimpse into the big sea of giant private market deals. Deals of such calibre are giving birth to a rising influx of investors flocking towards alternative investments.

But what are these alternative investments, and how do they operate?

Let’s find out. In this module, we’ll take a close look at alternative investments and learn how each type works. But first, let’s learn the vanilla definition of alternative investments.

At its core, alternative investments are financial assets that don’t fit into the conventional categories of stocks, bonds, or cash. These investments are unique, offering different opportunities and risks compared to traditional investments. They include a wide array of assets like:

• Real Estate: Investing in physical properties, either residential or commercial.
• Hedge Funds: Pooled funds that employ different strategies to earn returns for their investors.
• Private Equity: Investing in companies that are not listed on public stock exchanges.
• Commodities: Physical goods like gold, oil, or agricultural products.
• Collectibles: Items like art, wine, or rare coins.

Now, although alternative investments are more recent as a concept, it is important to note that these asset classes have been around for a really long time! Real estate, for instance, is one of the oldest investment assets and has been around for centuries, at the very least!

Let’s take a look at how the split of the different alternative investments in 2020.

Choosing between alternative and traditional investments is like picking a holiday spot:

Option one: a quiet mountain town. It’s out there, hard to get to, and your phone barely works. But man, the views! That’s your alternative investment. A bit tricky to get into, not always easy to handle, but can be really rewarding.

Option two: a lively city, full of art and buzz. Easy to get to, lots happening, and you’re never alone. That’s like your regular stocks and bonds. Straightforward and clear, but you’re in there with loads of other folks.

The table below summarises the differences between traditional and alternative investments.

1. Low Correlation with Traditional Investments

   Alternative investments are an excellent source of diversification. If we look into the history of asset performances, a clear pattern emerges. During times of notable crashes in the stock market, alternative assets have shone out. In some cases, the extent of the decline was simply lower. In others, alternative assets have even reported minor growth.

    

   Case study: Performance of Hedge Funds During the Dot-Com Bubble Burst

   Premise:

   In the 1990s, internet-based companies really took off. Money flowed into the market and valuations soared to new highs in a matter of years. The dot com bubble peaked in the late 1990s and burst in 2000.

   The stock market bore the brunt of the blow.

   When the bubble burst in 2000, NASDAQ fell drastically. It lost about 78% of its value from its peak in March 2000 to its trough in October 2002.

   The hedge funds played it safe.

   Hedge funds were also active during the dot-com era but were not as heavily invested in tech stocks. During the crash, they employed strategies like short selling, market-neutral, and arbitrage strategies that cushioned the impact.

   For instance, the HFRI Fund Weighted Composite Index reported much smaller losses and even some gains during this period. While NASDAQ crashed and burned, the HFRI index showed a modest decline of around 1.5% in 2000 and posted positive returns in 2001 and 2002.

2. Higher Minimum Investments and Fees

   This space is characterised by much higher initial capital requirements as compared to traditional investments. Because of this reason, most retail investors don’t get the opportunity to participate in the private markets.

   In India, there is a minimum investment requirement of 1 crore in the case of all AIFs apart from angel funds. But, in spite of that, most funds require a higher minimum. As you can imagine, it’s quite an exclusive club. The global private markets are dominated by HNIs, UHNIs and institutional investors.

   Apart from that, alternative investments are often associated with higher fees. In the case of private funds, fees are generally charged on two different levels — the management fee and the performance fee.

   Most VCs charge about 2% management fees, which you have to pay irrespective of the performance of the fund. But, if the fund performance exceeds a certain benchmark level, say 10%, you’ll have to pay an additional 20% of the profits.

3. Longer Investment Horizons

   These investments are illiquid in nature. You cannot really dip your toes in and then back out if you decide it isn’t for you. Once invested, your money gets locked away for at least 5-7 years, maybe even longer.

   In the case of venture capital and private equity, for instance, investment horizons can last for about 10 years, on average. Another example is real estate. The investment period in this case lasts for at least 7 years.

4. Limited Regulations and Transparency

   Unlike traditional publicly listed assets, alternative assets tend to be more shy. They’re not always forthcoming about their performance. Instead, they require no small amount of coaxing.

   There is a lack of transparency about the operations and valuations of alternative investments. For instance, hedge funds are not required to disclose their activities and holdings in the same way mutual funds are, making it challenging for investors to fully understand the risks involved.

   Don’t worry, it isn’t a complete information blackout. Alternative funds have to declare from time to time, depending on the disclosure requirements of the market regulator. SEBI, for instance, mandates that alternative investment funds (AIFs) report their performance either on a monthly or quarterly basis.