You're reading the August 2022 issue of Automated Teller Machine (ATM) brought to you in partnership with Masterworks. Masterworks is a fintech platform that allows anyone to invest in SEC-qualified shares of multi-million dollar paintings by names like Banksy, Basquiat, and Picasso. In just three short years, Masterworks has built a portfolio of nearly $700 million in world-class artworks, introducing over 575,000 individuals to the $1.7 trillion art market. Seven of Masterworks’ last eight exits realized a net return of 17.8%+ each.
It goes without saying that 2022 hasn’t been an excellent year for the market. At the time of writing, the S&P 500 is down 19.77% year to date, with the Dow Jones following at -11.84% right behind it.
We’re also witnessing the painful economic path to recovery following Covid-19. In the United States, inflation reached a 40-year high this year. In the UK, the pound fell to an all-time low, with the Euro also hitting 20-year lows alongside it.
These bearish figures aren’t just impacting people’s portfolios either, but rather every aspect of finance. Consumer credit card debt is at all-time highs in the United States, and people are feeling the pinch of inflation pretty much everywhere, from the grocery store to the gas pump. Some economists are still hesitant to call this a full recession, but it’s clear that there’s been some pain this year, with more potentially on the way in the face of slow economic growth and shrinking market liquidity.
This brief overview of the last year can seem quite doom and gloom, admittedly. But the state of the market and overall economy naturally impacts how people choose to invest, which is why it’s important to outline. And as markets take a downturn and inflation rises, it can become even more important to find new ways to put your money to work and to protect your wealth.
Enter the exciting world of alternative investments. While markets have been feeling the pain, investors have increasingly been looking to alternatives asset classes to diversify their portfolios. And thanks to technology, it’s incredibly easy to start dabbling in alternatives like collectibles, artwork, and real estate, even without much starting cash.
But what are the factors contributing to the rise in alternative investing? And, are alternatives even an effective way to outperform the market or dodge a downturn?
In this edition of ATM, we’re covering the pros and cons of alternative investments, how they became popular in the first place, and what investing trends are around the corner so you’re better prepared.
What Are Alternative Assets?
An alternative investment is an investment that’s not a traditional asset class like stocks, bonds, or cash. In recent years, alternatives like cryptocurrencies and NFTs have largely been center stage. But digital assets are just one type of alternative investment, with other examples including:
- Derivative contracts
- Hedge fund investments
- Private equity
- Real estate
- Venture capital
Many types of alternatives have actually been around for much longer than our modern monetary system and the stock market. Take gold as an example. By approximately 1,500 BC, gold was the monetary system for the Ancient Egyptians, serving as a medium of exchange. Or, look to slightly more recent events, like the 17th century Dutch tulip bubble, which saw the sharp rise and crash of exotic tulip prices in Holland between 1636 and 1637.
The point is that throughout history, societies have always had some form of trading and collecting, whether it’s precious metals, artwork, or rare flowers.
But how did the concept of alternative investing start? In other words, when did people start looking at assets like artwork, fine wine, and trading cards as a potential way to protect and even grow their wealth?
Let’s take a look.
A Brief History of Alternative Asset Investing
If you’re a younger investor, it’s easy to think that the stock market only goes one way: upwards.
However, the reality is that the general market is much more cyclical, and, at times, brutal. Take some of the major crashes over the last century as an example:
- 1929 Wall Street Crash and Great Depression
- 1972-1973 Stock Market Crash
- 1987 Black Monday
- 2000 Dot-com bubble
- 2007-2008 Financial Crisis
- 2020 Covid-19 Market Crash
Considering that the market can and does have downturns, it’s not too surprising that people gradually began looking for alternatives to good ol’ fashioned stocks and bonds.
But one push for diversification began in the 1950s, when economist Harry Markowitz developed the Modern Portfolio Theory (MPT), which essentially theorizes how investors can build a portfolio that maximizes returns while quantifying the level of portfolio risk. This theory is actually the basis for many modern robo-advisors, and it marks a major moment in investing history and the argument for diversified portfolios.
However, MPT wasn’t the only catalyst for diversifying portfolios. Following the 1973 market crash, the U.S. government passed the Employee Retirement Income Security Act (ERISA), allowing pension funds to invest in more types of assets. Across the pond, The British Rail Pension Fund began investing in artwork as a means to diversify its portfolio that same year.
Of course, there were other notable events and changes to investing strategy that occurred in the 20th century. The world saw the creation of the first artwork fund, the first hedge fund, and plenty of legislative changes relating to real estate investments. Put all of these factors together, plus some technological advancements which I’m about to cover, and you get the framework for the world of alternative investments we have today.
The Modern Rise of Alternative Investments
According to a 2020 survey by KKR, ultra-high-net-worth investors ($30 million+) allocated 50% of their portfolios to alternative assets and high-net-worth investors ($1 million+) had 26% of their portfolios in alternatives. In comparison, alternative investments make up less than 5% of the average investor's portfolio according to Personal Capital.
But this doesn't mean younger, newer investors aren't interested in alternatives. In fact, a 2022 study from Bank of America found that 80% of young investors are now looking to alternatives like private equity, commodities, and real estate in hopes of achieving above-average returns. In contrast, investors 43 and older are still largely sticking with equities.
So, it's clear that the younger wave of investors are starting to dive into a wider range of assets. And as the world has modernized, technology has played a significant role in bringing alternative investments to more people. These days, practically anyone can open an account with an online broker or investment app and begin trading traditional securities, but also alternatives. And the world of fractional investing now means that you can buy shares in assets like apartment buildings all the way to Lamborghinis.
Covid-19 and the most recent market downturn, coupled with inflation, has also seen a spike in alternative asset investing. Let’s take a look at what the data says, as well as how alternatives are becoming more mainstream.
Alternative Asset Investing Statistics
Preqin provides data and insights into the alternative investments market. And according to its 2022 annual report, it predicts significant growth in alternatives over the next five years.
Specifically, it found that assets under management (AUM) in private equity grew from $4.08 trillion by the end of 2015 to $8.90 trillion by the end of 2021. By the year 2026, Preqin forecasts a compound annual growth rate of 14.8%, bringing private equity AUM to a whopping $17.77 trillion.
This figure is still smaller than major stock exchanges like the NASDAQ. But what’s most important and interesting is that Preqin is forecasting the rate of growth in alternatives to increase, at least for private equity.
But other alternative categories aren’t slacking. Investments in hedge funds, private debt, real estate, and natural resources are also forecasted to continue growing.
Interestingly, Preqin’s data also estimates that the growth of alternative asset investing will occur quite evenly in three regions: North America, Asia-Pacific, and Europe. The rest of the world will still see growth, just not at quite as rapid of a pace:
According to Preqin, there are a few factors attributing to this rise in AUM for alternatives. The first is that private equity has traditionally had strong returns, so it’s natural for investors to continue pouring money into the space and to reinvest previous gains.
Alternatives in Pop Culture
Looking at data and forecasts is one method to gauge how alternative investing trends might play out. But in the past few years, it’s also been interesting to see the intersection of pop culture and investing, including in the alternatives space.
The crypto and NFT mania of 2021 is a shining example of this. For better or worse, celebrities, athletes, politicians, and influencers alike voiced their opinions about the merits, or lack thereof, of digital assets.
Some individuals, like Kim Kardashian, ended up getting fined $1.26 million by the SEC for promoting cryptocurrencies without disclosing that she was getting paid. In contrast, other individuals, like Elon Musk, managed to pump coins like Dogecoin and Shiba Inu to historic heights, all through the power of Twitter and memes.
And this is just in the world of crypto and NFTs. Thanks to COVID, stimulus checks, and perhaps widespread boredom, other alternatives also began to boom and become somewhat mainstream.
Take Pokemon cards as another example. In 2021, The Pokemon Company had to print 9 billion cards to keep up with demand and to maintain proper card supply. Investors piled into the highly-speculative investment, buying unopened packs in hopes of drawing rare, shiny Pokemon cards to flip for a handsome profit.
At its height, celebrities like Logan Paul were getting in on the action. In fact, Paul spent over $5 million on a PSA Grade 10 Pikachu Illustrator card. He also wore a First Edition Charizard necklace to his much-anticipated boxing bout with Floyd Mayweather.
A few years ago, I don’t think many people would have predicted investments like NFTs or Pokemon cards to take off how they have. But it goes to show how quickly the alternative investment space can move, but also how accessible it’s becoming.
New Investing Tech
As mentioned, improvements in investing technology has pretty much made all types of investing more accessible.
A perfect example of this has been the rise of retail investors. As more brokers have gone commission-free and investing apps like Robinhood have become popular, pretty much anyone can begin trading. You don’t need any experience, much capital, or even a game plan if your only plan is buying GME and holding it with diamond hands.
Naturally, an increasing number of “everyday investors” impacts the alternatives market. Crowdfunding is really the engine behind much of this growth, and it seems like there’s a new platform springing up every month that lets you buy shares of some different asset class.
Just take a look at some of the alternative investment platforms that have launched over the last decade or so:
- Masterworks: A platform for investing in blue-chip artwork.
- Collectable: Provides an easy way to buy shares of sports cards, sports memorabilia, sneakers, and other collectibles.
- Fundrise: A leading real estate crowdfunding platform that lets you start investing with only $10.
- Vinovest: Lets you invest in portfolios of fine wine or individual bottles.
- Yieldstreet: An alternative investment platform that offers its own unique funds as well as individual deals.
With investing minimums being as low as $5 and $10 in many cases, the barrier to entry for alternatives is gone. You don’t need to be an accredited investor anymore, or have a million dollars in the bank, to dabble in many of these asset classes. And you don’t need to know a hedge fund manager or deal with private funds either. To invest in alternatives these days, all you need is your smartphone.
This edition of the November ATM is brought to you by Masterworks, a leading artwork investing platform.
Masterworks lets you invest in shares of blue-chip artwork from artists like Banksy, Monet, and Picasso. This lets everday investors tap into the global, multi-billion dollar artwork industry. If you want to diversify your portfolio with artwork, Masterworks is one of the best solutions on the market.
The Argument for Alternative Investments
So, we’ve explored a bit of the history of alternative asset investing. We’ve also covered some of the investing trends in this space and factors that have alternatives more mainstream and accessible.
But is there an actual argument for alternatives besides the simple sake of diversification?
Lack of Market Correlation
One of the advantages of many alternative investments is that they don’t correlate strongly, or at all, with general market movement. In other words, if the market is on a bull or bear run, the value of certain alternatives doesn’t seem too impacted.
For a few years, cryptocurrency advocates thought that Bitcoin was the poster child for this. But in recent months, we’ve seen that Bitcoin, and many altcoins subsequently, have correlated with the market.
For now, it seems like crypto is out of the equation for downside protection, but what about other alternatives?
As it turns out, there are several popular non-correlating assets that investors often turn to. Real estate and precious metals like gold are perhaps the most common. But artwork is one of the most uncorrelated assets that you can invest in today, according to Citi's recent 2022 Art Market Report.
Investing in non-correlated or inversely-correlated assets is actually one strategy hedge funds use, and this is where the name comes from. By investing a portion of a portfolio in instruments that are uncorrelated or inversely-correlated to the market, hedge funds “hedge” their bets, providing clients with some downside protection. And while this won’t necessarily pay off during a bull run, it can certainly help in a bear market.
Another argument for investing in alternatives is to hedge against inflation. And considering how inflation has been at 40-year highs, this is certainly a compelling argument.
Once again, precious metals are a common hedge. The downside of buying pure gold and silver is that they don’t generate income. But options like mining or gold ETFs can help get the best of both worlds.
Collectibles like wine and art are becoming more popular inflation hedges as they become more accessible to everyday investors. According to Masterworks, art prices have outpaced both stocks and gold during periods when inflation was above 3%.
Real estate is another popular inflation hedge, and unlike most of the other assets mentioned, it does generate income. As more crowdfunding platforms launch and offer more funds, it’s only becoming easier to add real estate to your portfolio.
Potential For Outsized Returns
If you’re a passive investor, you might be content with dollar-cost averaging your way into the market with hopes of earning 7% annual returns or so. Personally, this is my sort of strategy, and I mostly stick with ETFs and Index Funds rather than individual stocks or alternatives. Some investors take this a step further, lowering risk even more by focusing on bonds and dividend stocks.
But if you want to outperform the general market, these strategies won’t work. In this case, you need to either invest in higher-growth stocks and funds or alternatives.
Whether or not an alternative asset provides better returns than the stock market greatly depends on timeframe. For example, gold has outperformed the general market in 2020 and 2021. But historically, stocks generally return more in the long run. And with crypto, it’s all too easy to cherry pick points where different coins either drastically outperform or underperform the market.
Crypto is a perfect example, and from 2011 to 2021, Bitcoin was the best performing asset class of the decade. In fact, it saw cumulative gains of over 20,000,000% in this time period versus the Nasdaq’s 541% return.
You simply can’t find these types of returns with basic dollar-cost averaging into the S&P 500. And it’s perhaps this reason why there will always be a class of investors holding Dogecoin, rare Pokemon cards, or Ape NFTs, hoping to strike it big.
Things get a bit more interesting when we look at longer-term alternatives that can lead to outsized returns.
For example, according to artwork investing platform Masterworks, contemporary art has outperformed the S&P 500, real estate, and gold from 1995 to 2021, and by a meaningful margin:
Just this November, the historic auction house Christie's sold $1.5B+ of art in a single night. That shattered the previous record by over 63%.
We see a similar story with wine investing. According to wine investing platform Vinovest and data from Liv-Ex, fine wine has also outperformed the S&P 500 from 2000 to 2018:
Finally, real estate has also outperformed the S&P 500 at different points in time. And according to data from The National Association of Real Estate Investment Trusts (NAREIT), it’s only within the last decade that the S&P 500 has been outperforming REITS:
So, it’s clear that certain alternative assets can outperform the general market. And some of these assets are also uncorrelated, so they can provide a bit of downside protection.
This begs the question: why don’t more people invest in alternatives to try and get outsized returns and diversify their portfolios?
Alternative Assets & Annual Returns – Are They Too Good To Be True?
The last argument for alternatives – that is, outsized returns – is probably the most exciting argument. After all, who doesn’t love the idea of beating the market? Many alternative investment platforms often tout annual return figures in the 10-15% range, or even more in some cases. But, depending on the asset and platform, these numbers could be somewhat misleading.
With certain alternatives, these lofty returns may only be possible if you purchase the asset early and hold it for several years before selling. With wine and spirits, for example, older vintages and casks are more valuable than younger ones. So if you buy a young cask, it may only raise a few percentage points in the first few years before really gaining steam down the line. You’re not generating income each year in the meantime, which is a notable downside.
These factors can muddy the waters when it comes to calculating “annual” returns on certain alternative investments. Also, if you can’t find a buyer for your alternative asset, you might have no realized returns at all after years of holding.
Finally, it's important to evaluate how the reported annual returns for a particular asset are being tracked. Unlike with stocks, it's difficult to capture every transaction of wine, art, sports cards, or other alternatives. There are certainly indexes that try to approximate the returns of these asset classes. But often these indexes only track the most sought-after items in a specific category. So if you don't happen to own one or more of those items, your personal returns are likely to be different.
Other Potential Risks Investors Should Consider
Every alternative asset class and individual deal can be different. But generally, there are some risks and downsides to this type of investing that are worth considering:
- Liquidity: Oftentimes, alternatives are highly illiquid. Even if an investing platform or firm has a secondary marketplace or says that it allows cash outs, liquidity might not be guaranteed.
- Fees: Many alternative investing platforms charge asset management fees that are often 2% or higher. Others may require to pay a seller fee if you exit an investment early.
- Due Diligence Requirements: Dollar-cost averaging into various index funds is a very passive way to invest. But how much time does researching Pokemon cards, contemporary artwork, or private REITs take? The chance for fraud or lackluster investments is very real in the world of alternatives, so a lot of due diligence is required.
- Potential Tax Implications: Some alternative assets can create tax implications that can be a headache to manage. Crypto and NFT income is one example, and if you’re dealing with serious volume, you’ll probably want special crypto tax software and some accounting help to ensure you accurately report gains and losses.
- Some Accreditation Requirements: Fractional investing has helped remove barriers to entry for many alternatives. But some deals, especially when working with hedge funds or private equity firms, still require you to be an accredited investor.
The Future of Alternative Asset Investing
There's no single “right” answer for creating a diversified portfolio. And no investor has a magic crystal ball that lets them know how the market, or world for that matter, might change in the future.
But if the last few years have reminded us of anything, it's that volatility is an inevitable part of investing. Considering this fact, the steady rise of alternative asset investing really isn't too surprising as people continue to search for ways to protect and grow their wealth. And thanks to crowdfunding companies and technology, you don't have to be a millionaire to get started,
That said, I don't think stocks, bonds, and good old fashioned cash are going anywhere anytime soon. However, it's clear that there are some advantages to a robust portfolio, whether that's simply downside protection or the potential for outsized returns.
Ultimately, how much of your portfolio you dedicate to alternatives depends on your goals, risk tolerance, and if you even want to dabble in alternatives in the first place. Thankfully, it's never been easier to get started thanks to various crowdfunding platforms and investing tech. But you still need to do your research and due diligence before jumping in.
This edition of the November ATM is brought to you by Masterworks.
Masterworks is a fintech platform that allows anyone to invest in SEC-qualified shares of multi-million dollar paintings by names like Banksy, Basquiat, and Picasso. In just three short years, Masterworks has built a portfolio of nearly $700 million in world-class artworks, introducing over 575,000 individuals to the $1.7 trillion art market. Seven of Masterworks’ last eight exits realized a net return of 17.8%+ each.