By Michael Wang, CEO and Founder of Prometheus Alternatives Investments
As the number of investors who realize that they will fall short of their long-term savings goals with a traditional 60/40 portfolio of stocks and bonds increases, so does their appetite for alternative investments. It's no coincidence. By 2025, total alternative investments under management are projected to reach $17.2 trillion—a four-fold increase since 2010. Almost all that money is from institutional investors and ultra-high-net-worth families. The latter group was reported as having 50% of their assets in alternatives in 2020. If we look at billionaires alone, the percentage of assets allocated to alternatives is even higher, at around 51-54%.
However, the projected total value of the alternative assets under management is just a tenth of the $170 trillion in assets collectively held by high-net-worth individuals globally. It's this capital that needs help to be deployed, unfettered by archaic regulation and other barriers to entry.
For the time being, "alternative investments" remains a term I have to explain pretty often in my interactions with people outside of the finance industry. Over the years, I've boiled that explanation down to simply this: stocks, bonds, and cash are traditional investments. Everything else can be put in a bucket labeled "alternative investments."
For good measure, I'll typically list hedge funds, crypto funds, venture capital, private equity, commodities, real estate, private debt, and art and collectibles as examples of alternative investments or “alts” for short. Sure, it's a pretty disparate list of products, but it's what they have in common that's fueling the appetite for alternatives.
An attribute all alts share is they are less correlated—in some cases completely uncorrelated—to the broader market. That's not something investors have had to be too cognizant of during the longest bull market in U.S. history, but given the significant macro headwinds we face, it's an incredibly important characteristic.
A second thing they have in common is that alternatives offer downside protection. If you're just long equities and the market takes a hit, your portfolio is going down with it. You're going down a multiple of that if you own tech stocks because tech stocks have higher beta—the measure of a stock's volatility. Many hedge funds protect investors in down markets because they're short stocks, as well as also being long stocks. That means that there are instances where the market may be down a lot, but hedge funds are up. Even today, some hedge funds are generating positive returns and significant outperformance in a difficult year thus far for the overall market. Unless you're in cash, that's simply not something you can do with traditional assets.
A third characteristic of alternatives is that they have the potential to generate significantly higher returns than traditional stocks and bonds. According to Cambridge Associates—a consultancy that advises large institutions on investing in alternatives—private equity returned 22% and venture capital 25.8% over the past five years. Compare this with the 17.6% that the S&P 500 returned over the same period.
Given the protection offered by alternatives against prevailing market conditions, you'd be right to wonder why more everyday investors aren't putting their money into alternatives. There are three main reasons. The first reason is the accreditation issue.
Rules passed in the wake of the Great Depression limited investing in anything other than stocks and bonds to people who made a certain amount of money or had a certain amount of wealth, designating them as "accredited investors." Did it make sense then? Maybe. Does it make sense when there's nothing to stop anyone from putting everything they have into a particularly dubious altcoin? Absolutely not.
To be an accredited investor in 2022, you need to earn over $200k per year—$300k if you're a couple—or have a net worth of over a million dollars, excluding your primary residence. Anyone who is able to invest should be able allocate a significant portion of their portfolio to alternatives. Strongly advocating for the reform of investment legislation from a bygone era is important, but the true democratization of access to alternatives is out of our hands.
For the time being until regulations change, the focus should be on the other two problems accredited investors encounter when attempting to invest in alternatives: high investment minimums and the lack of an accessible platform to transact in alts.
Even if you are an accredited investor, the cost of admission is high: most alternative funds have at least a $1 million minimum investment threshold. Many hedge funds and private equity funds even have a $5 million minimum. This is a steep price to pay even if you are quite wealthy and represents yet another hurdle for broader participation in alternatives. By lowering minimums and creating access funds (also called feeder funds) a ton of smaller checks can be pooled into one large check that at the very least meets the minimum investment requirement for a typical hedge fund or private equity fund. Thus, these funds can lower the cost of admission for an individual investor interested in investing in an alts fund from $1M to say $25k.
Now, let’s say you meet both the accreditation threshold and have the means to meet the minimum investment requirements of most alt funds. First, good for you! Second, how are you going to access alternatives? Accredited investors must now look for tools that allow them to discover some of the world’s best hedge fund, private equity, venture capital and crypto fund managers, follow their content to get to know the managers personally, and easily invest in their funds – as market volatility continues.
Michael Wang is a veteran hedge fund manager, formerly of SAC Capital, Tourbillon, and Cypress Funds, and the CEO and Founder of Prometheus Alternatives Investments.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.