WHY THE ULTRA-WEALTHY PREFER ALTERNATIVES TO WALL ST.

– August 05, 2019 – 767
– August 14, 2019 – 800
– August 22, 2019 – 622

Did you decode the significance of the dates and numbers above?

If you guessed the numbers on the right are the number of points the Dow dropped on the dates to the left, then you would be correct. Recent talk of low Treasury yields and trade wars have put a damper on the markets and left many investors on edge wondering why they’re so heavily invested in the stock market in the first place.

So why do so many investors stick with Wall Street despite its volatility and unhealthy codependency on the broader economy?

The most straightforward answer is convenience – and low barrier to entry. The stock market is a known commodity making it easy for investors to get started in and stick with it. Through online trading platforms like Etrade, Charles Schwab, TD Ameritrade, Fidelity, etc., even novices can start trading almost immediately from the convenience of their phones and can buy as little as one share in any listed company. Moreover, with brokers, dealers, financial planners, and retirement and pension plans all married to Wall Street products, many investors may simply believe there are no other options.

What are the alternatives?

An alternative investment, by definition, is a financial asset that does not fall into one of the traditional investment categories such as stocks and bonds. Common alternative investments include real estate, private equity, hedge funds, commodities, precious metals, startups, derivatives, venture capital, and cryptocurrency.

Because alternatives tend to behave differently than traditional stock and bond investments, they have historically been favored by ultra-high-net-worth individuals (“UNHWIs”) as a hedge against recessions and inflation as well as for generating above-market returns. That’s because alternative assets are not correlated to the stock market, offer diversification, and potentially higher risk-adjusted returns when compared to stocks and bonds.
 

 

The chart above demonstrates alternative investments outperforming traditional investments for risk-adjusted annualized returns. Real estate returns (as reported by the National Council of Real Estate Fiduciaries), hedge fund returns (represented by the HFRI Asset Weighted Composite Index) and a portfolio consisting of alternative investments all outperformed traditional investments.

You may be wondering why UHNWIs have generally favored alternative investments while the rest of the investing public has favored stocks and bonds. Historically, it has been less about a matter of choice, and more an issue of access, high barriers to entry and liquidity.

Up until recently, alternative investment opportunities like private equity, real estate, and hedge funds have exclusively been available to the wealthy. That’s because until recently, with the launch of the Jobs Act in 2016, private investment opportunities were typically only communicated by word of mouth since advertising and general solicitation were strictly prohibited for prospecting potential investors. This rendered private investment opportunities such as private equity, real estate syndications, and hedge funds inaccessible to investors that weren’t wealthy and well-connected.

Because there is no public market for alternatives such as private equity and real estate, such investments have traditionally required high initial entry points and been illiquid. Although the Jobs Act opened up more investment opportunities for the general investing public by lowering the cost of entry, alternative investments remain relatively illiquid. However, that’s not a bad thing because alternative investments save investors from their own impulses, unlike the stock market that is always at the mercy of the instant online trade. An investor can exit a stock position almost as quickly as they entered it.

Real estate is not nearly as liquid, but it does reward investors for their patience through not only consistent periodic income but also appreciation.

Although access has been a significant factor in keeping many investors from participating in alternative investments, misconceptions have also played a part. Many myths surrounding alternative investments have kept investors from enjoying the recession hedging returns relished by UHNWIs.

Do any of these myths sound familiar to you?

  • Myth: Alternative investments are more volatile than stocks and bonds. The fact is, many alternatives are far less volatile than the stock market because they’re less correlated to the broader market.
  • Myth: Investors cannot access their money if they invest in alternatives. The reality is, although alternative investments as a whole are less liquid than stocks, liquidity will vary depending on the investment. For example, some private equity funds may allow for early redemption, relieving investors from the worry of tying up their funds for the long term.
  • Myth: Only institutional and ultra-high-net-worth investors can access alternatives. With the passage of the JOBS Act and innovations in deal structures such as hybrid equity, the fact is, qualified individual investors now have greater access to alternatives than ever before.
  • Myth: Alternatives will not protect investors during market downturns. The reality is that in times of extreme economic stress, many investments may be adversely affected in one way or another. However, history has shown that alternatives typically don’t fall as far as stocks, providing a cushion for investors.
  • Myth: Alternatives are too expensive and out of reach. The reality is, once again, because of the JOBS Act, the cost of entry has lowered through good old fashioned competition.

There are many reasons the wealthy have long favored alternative investments. During good times and bad, they offer higher risk-adjusted returns than their Wall Street counterparts, and in bad times, they offer a hedge against disaster.
Investors who can wade past the myths that have historically dogged alternative investments can find the path to true wealth many investors have already successfully navigated.

About the author

Kyle Jones is a co-founder and Key Principal of TruePoint Capital, LLC. Kyle is responsible for the company’s strategic planning, investment decisions, asset management, and overseeing all aspects of the company’s financial activities, operations, and investor relations.

Kyle obtained a Bachelor of Science degree from Texas State University – San Marcos, where he also played Division 1 Baseball.

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