What are alternative investments?

An alternative investment is a financial asset that does not fall into the conventional category of publicly traded stocks, bonds, and cash. It typically includes private equity, private credit, and hedge funds.

The size of the private equity market is about US$12 trillion, private credit is over US$1 trillion, and the hedge fund segment is about US$4 trillion. 

While this is still a fraction of the public securities market, it has been rapidly growing as a real allocation to portfolios not only for institutional investors but also for individual investors. A recent Goldman Sachs survey on family offices shows that family offices have allocated 26% of their assets into private equity.

While alternatives are still not widely available for the general public due to lack of access, large minimum investment hurdles, and high cost, Endowus has been expanding its alternatives offering to offer high-quality products in each sub-segment.

Why include alternative investments for your wealth management needs?

Depending on the individual’s specific needs and circumstances, the three main reasons investors might consider investing in alternatives are to a) improve returns, b) lower volatility and correlation, and c) get access to further diversification.

a. Improving returns

The global public equities market has returned an average 7% per annum over a multi-decade period. We will call this average 7% return the “public equity beta”. There are only a few ways to improve returns above the public equity beta over a longer-term period. These include i) alpha, ii) illiquidity premium, and iii) leverage. 

Alternative investments give portfolios a chance to improve returns. This is because alts have a higher chance of alpha generation with private opportunities that are available only for a small group of investors (versus for all investors in public markets). There may also be greater flexibility of investments, with the absence of benchmarks and the use of shorts and derivatives.

Alternative investments also give portfolios higher returns through illiquidity premiums. Long-term capital that does not need to be withdrawn can demand higher returns from companies that need funding.

Lastly, alternative investments can generate higher returns through the use of leverage. Many private equity funds and hedge funds use leverage as a means to improve returns if the underlying asset has strong fundamentals and/or has relatively little risk.

b. Lowering volatility and correlation

Alternative investments tend to have lower volatility as compared with the public markets, as alternatives mark to market much less frequently. Private equity firms would value their funds on a quarterly basis, and the marks would typically tend to be based on “events” such as the pricing of the latest fundraising round of the company. As such, it would not have to go through the daily volatility that public markets go through. 

Hedge funds tend to have lower volatility and correlation because of their use of shorts and derivatives. The idea of a hedge fund is to “hedge” the risks where it doesn’t have a view, and typically a hedge fund would at least partially hedge market risk (or public equity beta), and thus lower its volatility and correlation.

c. Providing broader diversification

Alternatives can provide broader diversification to a portfolio, as it gives access to private companies that are otherwise not available for investments in the public markets. The universe of private companies is getting larger as private companies stay private for longer.

Alternatives would also likely have more flexibility to include segments that are otherwise not available in the public markets — such as aircraft leasing, ownership to sports franchises, senior housing, and music intellectual property (IP), among others.

Hurdles and risks for alternative investments

The main hurdles for individual investors when it comes to alts products would be a) lack of access, b) large minimum investments, c) liquidity constraints, and d) complexity of the investment. 

At Endowus, we are working to overcome these hurdles as we provide access to multiple high-quality alternative investments mainly for accredited investors. 

Our alternatives have a minimum of US$50,000 – US$100,000, compared with the large minimum investment sizes of at least US$1 million for direct investments, and US$250,000 minimums at private banks. An individual who wants to qualify to be a private bank client will also have to satisfy high minimum requirements to begin with.

The liquidity profiles of our products are generally better than going direct, as our pooled capital enables us to overcome fund gates, while our focus on open-ended private funds provides quarterly liquidity with limited lock-ups.

As for complexity, we do our best to provide education through webinars and in-person events, with access to the fund managers to explain the asset class and product. 

As discussed earlier, alternatives provide many benefits to complement an existing public portfolio. Moreover, Endowus has made it much easier for individual investors to access alternatives by lowering the hurdles. 

With all of that said, it is also important to understand the risks of alternative investments — such as a) liquidity, b) leverage, c) cost, and d) transparency.

a. Liquidity

Liquidity is a key risk for alternatives because of the long fund life, notice periods, gates, and lock-ups that make it hard to access your capital. This is due to the potential mismatch of the liquidity of underlying investments and the liquidity of investors. Moreover, liquidity in investments that are not diversified by region, vintage, or asset class, may be at risk in times of crisis. As such, it is important to be invested in alternatives that are as diversified as possible.

b. Leverage

Leverage is another key risk for alternatives. Leverage is a double-edged sword that can be powerful when used properly, but dangerous when it is abused.

c. Cost

Cost is also a risk that can dilute the performance of your portfolio over the long run. Cost can include anything from a high management fee and performance fee — also known as carry — or the overuse of beta hedging that dilutes market performance. 

We believe there is a place for alternatives in your portfolio, but a proper understanding of the benefits and risks would determine the right allocation of alternatives for you.

d. Transparency

Alternative investments such as hedge funds are not as regulated by regulators as compared with fund vehicles such as unit trusts, which means the disclosure may not be as standardised as other retail products. Information on alts products may also be less easily assessed by investors. 

Start your alternative investing and wealth management journey with Endowus Private Wealth

Endowus has a private wealth arm that provides access to more investment products such as alternative investments. With Endowus Private Wealth, clients looking to invest a minimum of S$1 million in assets across our services can gain exclusive access to more personalised solutions and products.

Let us introduce you to a better way to manage your wealth. For more information, please contact us for a consultation.

Read more:

• Why become an accredited investor in Singapore
• A glossary on alternative investments
• An introduction to private equity
• Why invest in hedge funds