Alternative investments and access to private markets can provide diversification from traditional asset classes such as quoted equities, bonds and cash, and help create a more balanced investment portfolio, by targeting returns which are uncorrelated with public markets.
Alternative investments can also offer the potential for higher returns in exchange for less liquidity.
Alternative investment industry
Growth of alternative investments
It has been estimated that there was more than $13 trillion allocated globally to alternative investment asset classes at the beginning of 2022, with the total expected to exceed $23 trillion by 2026¹.
Alternatives are now mainstream. Demand has been driven from investors in pursuit of improved portfolio diversification, higher investment returns, and strong risk-adjusted returns.
Along with the increased demand has come increased access for private investors. Alternative investments are no longer the preserve of institutional investors such as pension funds and sovereign wealth funds. With access opened up, private individual investors are allocating increasing amounts to alternative investments.
In our 2022 Alternative Investment Survey, more than 4 in 10 private individual investors responded that they now allocate more 20% of their portfolio to alternatives. This mirrors trends in the institutional markets where, public pension funds tracked by Preqin have been steadily increasing allocations to alternatives over the past decade, with the median allocation rising from 18.1% in 2010 to 30.3% in 2020².
At Connection Capital we provide private UK investors with access to institutional quality alternative investments.
Traditional vs Alternative Investments
Traditional, liquid asset classes become highly correlated in times of market stress. Notable examples include the DotCom Bubble in 2000, the global financial crisis in 2008, the global pandemic in 2020 and the Russia Ukraine crisis in 2022, where stock markets suffered significant declines.
An investment portfolio may not be adequately diversified if the underlying assets derive their returns from the same sources of risk. In early 2022, against the backdrop of the lingering impact of the pandemic and the emerging Russia Ukraine crisis, both equities and bonds, which traditionally have an inverse correlation with each other, were both negative for the first four months of the year.
Investors should seek to diversify the sources of risk and the types of returns in their portfolios to the greatest extent possible.
Alternative investments offer experienced investors the opportunity to enhance returns and diversify their portfolios through access to a range of both concentrated (direct private equity) and diversified (funds) exposures in uncorrelated assets. Increasing the number of uncorrelated exposures can both enhance returns and mitigate risk over the market cycle.
Alternative investments tend to be less liquid than traditional asset classes. They cannot be traded on a public exchange and the 'hold period' of the investment can be longer than traditional assets. Investors expect higher returns for this illiquidty. This is known as the illiquidity premium (or indeed, the liquidity premium).
There is also a benefit of being able to stay invested through periods of market volatility.
Advantages of alternative investments
Improved portfolio diversification
A lack of diversification within an investment portfolio concentrates risk. If your portfolio is mostly invested in traditional asset classes – such as quoted equities and bonds – the value of your portfolio is strongly correlated to the wider economic environment. When markets decline, so does the value of your portfolio.
Access to alternative investments can expand your options. Investing in private equity, private debt, alternative asset funds or commercial property can provide access to growth and income that is not dependent on factors that affect traditional assets and may even benefit from wider market volatility.
Target higher returns and reduced risk
Independent research from the BVCA (The British Private Equity and Venture Capital Association) has shown that UK private equity and venture capital funds have continued to outperform the FTSE All-Share every year for the last three decades.
Investors are rewarded for less liquidity and longer investment terms when higher returns are achieved.
¹PreQin 2022 Global Alternatives Report
²PreQin: Future of Alternatives 2025 Report
Types of alternative investments
Alternative investment asset classes include private equity, hedge funds, property, venture capital, commodities, loans to private companies all the way through to art, fine wine and music royalty rights. They are investable assets which are the alternatives to the traditional asset classes: equities, bonds and cash.
Capital invested in private companies (i.e. not publicly listed or traded) in exchange for equity. Investors target returns through capital gains as a result of value growth. They may also receive returns through yield and loan repayments, depending on the structure used.
Capital invested in private companies as a loan targeting returns via yield and loan repayment.
This includes office buildings, warehouses, shopping centres, hotels etc. Returns can be through through yield (via rental payments) or capital growth if the asset's value appreciates.
Funds operating strategies concerned with alternative investment asset classes e.g. private equity. They offer investors a diversified approach to a particular strategy.