The benefits & challenges of alternative asset investing

Investing in alternative assets can be a personally rewarding and highly lucrative endeavor. These asset classes offer investors the potential for higher returns than traditional stocks and bonds – but investing in alternatives also involves its own unique set of risks that must be considered before taking the plunge. In this blog post, we’ll examine the benefits and challenges associated with investing in alts, putting factors like liquidity, volatility, risk profile, and more under the microscope so you can make an informed decision about how these investment vehicles fit into your strategy.

In this post, we’ll cover:

• What alternatives assets are
• The challenges of investing in alternatives
• The benefits of investing in alternatives
• Who should consider investing in alternative assets
• How to deploy alternatives

What are alternative assets?

“Alternative asset” describes any investment vehicle besides traditional assets, meaning stocks, bonds, and cash/cash equivalents. Alternatives, also known as “alts,” can be found in both the public and private markets, often in inefficient sectors. This includes, but is certainly not limited to:

• Collectibles
• Commodities
• Cryptocurrency
• Hedge funds
• Private debt
• Private equity
• Real estate
• Venture capital

The challenges of investing in alternative assets

While alternative assets are a critical component of a well-diversified portfolio, they do come with some inherent challenges.

Higher fees & transaction costs

Alternative asset investing has traditionally been structured for high-net-worth individuals (HNWIs) and institutional investors. This means many investments require a large initial outlay of cash that would be far out of reach for the average retail investor. The rise of fractionalization has helped curb this phenomenon, but new investors should still be wary of transaction costs that can add up. Depending on the asset, a single investment may come with additional fees, commissions, taxes, maintenance, legal expenses, and more.

Illiquidity/investment time horizon

Because many alternative investments are in the private markets, it may be difficult to buy or sell them. Transactions tend to be larger, more complex, and occur less often, which creates a substantial degree of friction. In addition, private equity and hedge funds often implement lockup periods that prevent investors from selling or redeeming shares.

What’s more, alternatives appreciate slower than traditional assets. This means most investors have to hold their investments longer in order to realize a return, sometimes for a period of years.

Less regulation

The alternatives landscape is extremely varied and there is no single entity responsible for regulation. The U.S. Securities and Exchange Commission (SEC) is the regulatory body responsible for securities, but not all alts fall under this classification. New types of assets built on emerging technologies, like cryptocurrency, aren’t subject to any regulation or oversight whatsoever (yet). This means investors must be extremely cautious and perform thorough due diligence before committing capital.

Higher risk

While they offer the potential for higher returns, investors should be prepared to stomach a higher level of risk when incorporating non-traditional investments into their portfolios. An investment may require a large monetary commitment upfront with fewer disclosures on the part of the entity taking the capital. Combining this with the aforementioned illiquidity and long investment time horizon means investors take the chance of realizing a total loss once they’re locked into a deal.

The benefits of investing in alternative assets

Sophisticated investors value alternative assets for the unique features that set them apart from traditional equity and bond investments.

Lower volatility

The illiquidity of alternatives is not necessarily always a bad thing. For investors seeking to diversify their portfolios with assets that have lower volatility, alternatives offer a strategic solution. Because markets are so illiquid, the value of most alts, like art, wine, and real estate location, fluctuates minimally from day to day.

Diversification

Alternative assets can be an important part of a diversification strategy since investors have a broad range of strategies and sectors to choose from. The asset class as a whole typically bears little to no correlation with mainstream securities markets, which helps reduce exposure to potential value fluctuations. While diversification doesn’t guarantee profit or totally guard a portfolio against losses, it can help reduce volatility over time.

Inflation- and recession-resistance

To successfully hedge against inflation, a portfolio’s rate of return needs to outpace the inflation rate. Alternatives, particularly real assets (tangible items with intrinsic value, like collectibles or precious metals), do this quite well. Although their prices in the short term can be hard to predict, alternatives that are real assets are generally expected to increase in value over time. This helps mitigate the impact of potentially harmful market conditions, like inflation or even recession.

Equity appreciation

When the value of an asset increases, an investor’s equity – or ownership stake – in that asset also increases. This can lead to significant gains over time, making real assets a popular choice for investors looking for long-term growth. While the rate of appreciation can vary depending on the asset and the market, real assets have historically provided a reliable path to building wealth. 

Passive income potential 

Alternative assets can be a great addition to an income investing portfolio, which, if done correctly, can generate consistent cash flow. This passive income can provide a cushion against salary cuts and job loss, as well as supplement a household on a fixed income – all without the investor having to take on an additional career.

Who should invest in alternative assets?

In recent years, alternatives have become much more accessible to retail investors. The definition of accredited investor was expanded in 2020 to include individuals with investment professional credentials as well as knowledgeable employees of private funds. This made a larger sector of the population eligible to invest.

That being said, there are certain investors who stand to gain the most based on the inherent features of this asset class, particularly those who are seeking:

• Broader diversification
• To cultivate regular distributions
• To hedge their portfolio against inflation
• To reduce long-term volatility
• To invest in recession-resistant industries

How to deploy alternative assets

As we’ve touched on briefly, diversification is at the core of modern investment strategy and there are many ways for retail investors to start incorporating alternatives into their portfolio. The simplest investment strategy is direct ownership, though this is only practical for certain asset types. This method often requires a substantial time commitment for management and maintenance, especially for real assets that require specific storage conditions like art or wine. For investors who don’t want the added burden of direct ownership or who simply prefer to invest more passively, digital platforms like Yieldstreet make it easy to invest in alt-focused funds developed by experienced managers.

While success is never guaranteed, ensuring that a portfolio contains a wide variety of asset classes can potentially yield returns greater than the S&P 500, depending on the asset type, investment term, and economic factors at play. Alternatives play a key part in this approach and are typically most appropriate for investors who already have some experience investing in more traditional assets. Once you’ve built a solid foundation of lower-risk investments, you’re well-positioned to take advantage of these more sophisticated investment vehicles.

Franchising as an alternative asset

When it comes to alts, we’re obviously partial to franchise investing, but with good reason. Franchising carries many of the benefits of other alternative assets, including:

• Recession- and inflation-resistance
• Regulation by both the FTC and SEC
• Low volatility with high-yield potential
• Equity appreciation
• Passive income potential and low startup cost (when investing fractionally)

Passive franchise investment with FranShares

The expense and learning curve involved in actively managing a franchise prevents many retail investors from taking advantage of this important alternative asset class. The requirements for net worth and initial investment capital are simply too high (and perceived as too risky).

Now, FranShares allows accredited investors to participate in a fractionalized fund of start-up franchises for as little as $500. This provides an entirely passive way for investors to participate in the franchise asset class without the need for heavy upfront investment, specialized training, or major upheaval in their personal or professional lives. 

To learn more about FranShares and this unique opportunity, sign up for our platform on our home page.