Diversifying Beyond Real Estate: Exploring Popular Alternative Asset Opportunities

Insights From the Publisher: Real estate remains a popular alternative asset class but with alternatives continuing to become more popular, investors may also want to consider other asset classes.

By Damon Elder, publisher and editor-in-chief, The DI Wire

As of Oct. 29, 2024, the total market cap for the Standard & Poor’s 500 was approximately $48.8 trillion. As of June 2024, the most recent data available, the value of the U.S. residential market – which includes single-family homes, condos, townhouses and multifamily properties up to four units – was equal to $56.4 trillion, according to the Federal Reserve’s April 2024 Financial Stability Report. Finally, also according to the Federal Reserve’s spring report, the commercial real estate market was valued at $22.5 trillion as of the fourth quarter of 2023.

Real estate is one of the largest asset classes and has long been a cornerstone of investment portfolios, and for good reason. It offers several potential benefits, including appreciation, income generation, and the opportunity for diversification. With the investment landscape continuing to evolve, however, alternative investments are gaining in popularity.

Savvy investors are increasingly diving deeper into the alternatives landscape to explore other investment options that may provide unique advantages or may be a better fit for their timeline or risk tolerance. Alternative assets like private equity, venture capital, private credit, commodities, and structured products are all potential options that investors may want to consider.

Private Equity 

Private equity is a broad category that involves investing in companies that are not publicly traded. A crucial part of any private equity investment involves the relationship between the investing firm and the company receiving the investment, as often times, these investments involve the investment firm actively managing and attempting to improve the operational efficiency of the acquired company.

If the acquired company is successfully grown, it may eventually be sold or taken public, offering the potential for significant capital appreciation. Private equity may also provide diversification benefits due to its relatively low correlation with public markets, but it is also fairly illiquid and often requires a long-term investment horizon. It may require substantial capital, but individuals with a higher risk tolerance could find private equity an attractive investment option.

Venture Capital

Venture capital is a specific type of private equity that focuses on investing in startups and early-stage, high-growth potential companies. Today, this often involves the technology or biotechnology sectors. As with any private equity investment, this asset class can offer the possibility of extraordinary returns if the invested companies achieve significant success, such as through initial public offerings. As there can be a high probability of failure for many startups, investors should carefully consider the venture capital firm, the startup company, and their own risk tolerance. For those with a long-term investment horizon and a high-risk appetite, venture capital may be appealing.

Private Credit

Private credit, also known as private debt, involves lending to companies or projects outside of traditional banking channels. Any company, private or public, may borrow via private credit; the “private” in private credit refers to the non-bank lender, often a private equity firm or alternative asset manager.

Private credit differs from private equity in that the private credit firm is making a loan rather than buying equity in the company. Private credit is commonly utilized by small and midsized firms that need additional capital to grow their businesses and cannot receive loans through traditional banks. This happens when banks become more conservative, such as during high interest periods or when a firm is highly leveraged and cannot borrow in a corporate bond market. Private credit can then step in and fill that lending void.

As private credit loans are typically made at a higher interest rate than traditional bank loans, this asset class may offer higher yields compared to traditional fixed-income investments, as well as the potential for capital appreciation if the loans are structured with equity-like features. Private credit may carry illiquidity concerns for investors, as well as complex associated risks and additional higher fees for management. Still, investors with a significant understanding of credit markets and a longer time horizon can choose to consider private credit.

Commodities

Commodities is a diverse asset class comprised of raw materials and includes energy products such as oil, gas, and coal; industrial metals such as gold, copper, and platinum; and agricultural products like corn, soy, and beef. Investors may purchase a commodity directly, such as a gold bar, or they may invest in a commodity fund, such as an oil and gas fund that owns several wells in a certain geographic location.

As with all asset classes, commodities investments has benefits and drawbacks. They may offer potential returns through price appreciation or income generation and can provide a hedge against inflation due to their low correlation with traditional assets. Commodity prices can be highly volatile, however, and are often influenced by geopolitical events, supply and demand dynamics, and global economic conditions. Investors seeking to hedge against inflation or diversify their portfolios may want to consider commodities.

Structured Products

Structured products are relatively new to the investment landscape. These assets are pre-packaged investments that typically combine a traditional security with a derivative component – a security whose value comes from an underlying asset. This derivative component can be linked to various underlying assets, including stocks, bonds, commodities, or indices. Structured products are designed to offer customized risk-return profiles that may not be readily available through traditional investments.

An example of a structured note is a credit default swap, a financial derivative that allows an investor to offset or “swap” their credit risk with that of another investor. To swap the risk, the buyer must pay a premium to the seller. Another example is a collateralized debt obligation, which pools together cash flow-generating assets and repackages them into tranches that may be sold to investors.

Structured products can provide customized risk-return profiles tailored to each investor’s specific needs and risk tolerance. They may also offer enhanced returns and diversification benefits, as they provide exposure to a wider range of assets and strategies. These products, however, can be very complex for the average investor. Investors must thereby, do their due diligence before investing, as should be done with any offering. There may also be counterparty risk, which means that the investment issuer may be unable to fulfill their obligations. Investors with specific needs and interests who are willing to understand the nuances of this asset class may be a good fit for structured products.

All asset classes offer varying degrees of risk and return potential, catering to different investor profiles and objectives. Alternative assets, such as private equity, venture capital, private credit, commodities, and structured products, are no different in that regard. While these investments may offer significant advantages, including diversification benefits and enhanced returns, it is crucial for investors to thoroughly understand the risks involved before investing in any asset class. By carefully considering their own individual risk tolerance and investment goals, doing their due diligence, and consulting with their investment adviser, today’s investors may find that alternative assets can be an important addition to their portfolio.

This article is for informational purposes only and should not be considered financial advice. It is recommended to consult with a qualified financial professional before making any investment decisions.

Damon Elder is the publisher and editor-in-chief of The DI Wire, as well as president of Spotlight Marketing Communications. He has worked in the alternative investments industry for nearly 20 years and was previously a congressional aide and political consultant before finding honest work in the private sector. Agree or disagree with what you read here? Share your views with him at damon@thediwire.com. Thoughtful replies may be published in The DI Wire.

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