How alternative investments can fit into one’s portfolio

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, while that of the private credit market surpasses US$1 trillion. The hedge fund segment is standing at 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. 

What are investor considerations for alternative asset investments?

The Endowus Private Wealth Insights: HNW Investor Sentiment 2024 report reveals a great investor interest in hedge funds, private market strategies, and real asset alternatives, with 3 in 5 respondents in Hong Kong expecting to strategically expand their private market strategies and hedge funds.

However, challenges persist in terms of managing private and public assets across different platforms, a lack of transparent and publicly available fund information, and a scarcity of high-quality products. Lack of access, large minimum investment hurdles, and high cost are other concerns. 

Endowus has been actively expanding its range of alternative investment offerings, aiming to provide professional investors in Hong Kong with high-quality products in each sub-asset class.

How can alternative investments be useful to investors?

Depending on the investor's specific needs and circumstances, the three main reasons investors might consider investing in alternatives are:

1. The potential to improve returns,
2. Lower volatility and correlation, and
3. Further diversification

The potential to improve returns

Global equities traded in the public markets have historically returned an average of 7% per annum, typically described as the “public equity beta”.

To improve returns above the public equity beta over a longer-term period, there are a few ways including generating alpha, capturing illiquidity premium, and the use of leverage.

Alternative investments have the potential to enhance investors’ portfolio returns by providing access to alpha-generation investment opportunities in the private markets. These opportunities are typically available only to a smaller group of investors, unlike the public markets. Additionally, alternative investments offer greater flexibility as they are not bound by benchmarks and allow for the use of shorts and derivatives, which can further improve returns.

Alternative investments also give portfolios a chance to potentially generate 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 potentially 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.

Lower volatility and correlation

Alternative investments tend to have lower volatility as compared with public markets as they 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.

Further 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 public markets such as aircraft leasing, ownership of sports franchises, senior housing, and music IPs, among others.

Risks associated with alternative investments

As discussed earlier, alternatives can 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, 

1. Liquidity,
2. Leverage
3. Cost, and
4. Transparency

Liquidity

Liquidity risk is a significant concern for alternatives due to long fund life, notice periods, gates, and lock-ups that hinder capital access. This risk is compounded when there is a mismatch between the liquidity of underlying investments and that of investors. Investments lacking diversification by region, vintage, or asset class may face liquidity challenges during times of crisis. 

Our focus on open-ended structures in private markets can generally provide investors with quarterly liquidity without the onerous lock-ups associated with alternative investments. Evergreen funds are investment vehicles with no fixed end date. They offer advantages like asset allocation rebalancing, immediate exposure to asset classes, flexible investment and redemption options, and diversified exposure.

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. 

Cost

Cost is a risk that can dilute the performance of your portfolio over the long run. Cost can include anything from high management fees and performance fees — 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. 

We don't charge upfront subscription fees, sales commissions, or platform/wrap fees like other distributors. Endowus Private Wealth provides access to alternative investment strategies at the lowest possible cost, with the same price promise as our unit trusts.

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. 

At Endowus Private Wealth, clients are assigned a designated SFC-licensed client advisor. From walking you through our platform to advising you on your personalised wealth management needs, they are here to help. 

Accessing alternative investments on Endowus Private Wealth

At Endowus, we are working to overcome these hurdles as we provide access to high-quality alternative investments for professional investors and family offices in Hong Kong.

With Endowus Private Wealth, clients looking to invest a minimum of US$1 million in assets across our services can gain exclusive access to top-tier alternative investments, more personalised investment plans, solutions and products.

Our hedge funds and private market strategies have a minimum investment threshold of US$50,000 - US$100,000. This contrasts with typical minimum investment sizes of at least US$1 million for direct investments. An individual who wants to qualify as a private bank client will have to satisfy high minimum requirements. 

Discover a better way to manage your wealth by contacting Endowus Private Wealth for a personalised consultation, or contact our private wealth arm via privatewealth.hk@endowus.com to learn more.

Read more:

• Why become a professional investor in Hong Kong
• Understanding private credit investing
• An introduction to private equity
• Why invest in hedge funds

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