The Introduction Series #2: The Advantages of Alternative Investing

The Advantages of Alternative Investing

Part 2 in a Series by Denis Shapiro

As you may already know, I’m a big proponent of individual investors allocating at least a portion of their portfolio to alternative assets, an often-overlooked class of investments that falls outside of traditional Wall Street assets and includes:

Real estate

Commodities

Private equity

Venture capital

Hedge funds

ATM machines

Life insurance policies

Collectibles

Foreign currencies

And more

 

Whether you’ve never looked into investments like these before or you previously decided they weren’t a good match for you, let’s take a closer look at why I believe they are worthy of more serious consideration.

A Closer Look at the Upsides of Alternatives

 

  • Lack of liquidity
  • Low correlation to the stock market
  • Diversification flexibility
  • Access to deals earlier in the life of the investment
  • Leverage your personal knowledge and network

The true magic of alternative investments is in their lack of liquidity.

While newer investors in this space may look at this as a blemish on the asset class, I look at it as the complete opposite. Many times, investors’ biggest regret is selling during a market correction. The market serves as a self-fulfilling prophecy: When the market starts going down, analysts come out of the woodwork to explain the downturn. Then, the explanation from the experts accelerates the downturn, people start to rethink their investment strategy, and they often sell at a loss with the thought that they’re minimizing the damage of a continuous downward spiral.

 

With an illiquid alternative investment, you have no option to rethink.

Instead, you invest based on a business plan that accounts for downturns in the economy. Prior to the investment, an advisor will present you with a best case, worst case, and most likely scenario in what’s called a “sensitivity analysis.” In the event of a severe downturn in the economy, your investment will enter the worst-case scenario, but you don’t see any actual losses because the asset hasn’t changed hands. This liquidity interference allows for better thought-out business decisions.

Low Correlation to the Stock Market

 

In reality, markets regularly correct to the tune of 10% on an annual basis. However, a report that the market is going down 10% because it’s “that time of the year again” wouldn’t sell many subscriptions to analysts’ reports; instead, the viewers receive a healthy dose of panic. To be fair, I usually see business reports representing both sides of the story, but the reporting is still skewed towards the potential of the bigger downside in the days to come. Even worse is when the market enters into bear market territory and suffers more than a 20% decline. All you see is red warnings flashing along the news ticker lines. If you’re brave enough and log in to your brokerage or retirement account during a bear market sell-off, you’ll find yourself thinking, “Hey, maybe I should have some assets in my portfolio outside of the stock market.” As it turns out, there’s a whole world of these assets that exist-they’re called alternative assets.

This concept was on full display during the 2020 COVID decline, when stocks- including real estate investment trusts (REITs)-saw a correction of 35%, yet most private commercial real estate, except retail, hardly moved (see image). Most private deals paused, saw an adjustment in their business plan, and moved on. Very few deals traded hands during the COVID sell-off, resulting in an exceptionally calm market during incredibly unknown times compared to the massive price movements that were happening daily on Wall Street. This is the benefit of reduced liquidity and why alternative assets are considered to have a low correlation to what’s happening in the stock market.

VNQ_YahooFinanceChart
Source: Yahoo Finance

Diversification Flexibility

 

When you invest in a public REIT-or, even better, an REIT exchange-traded fund (ETF), you will receive national exposure to the real estate market. While that may sound great at first, it violates real estate’s “golden rule”: location, location, location.

By contrast, if you learn how to invest in private real estate deals, you can pick the exact market you want, in the exact asset class you want, with the exact operator you want to partner with. This is powerful, and it stacks the deck for a more favorable outcome. For example, right now, states like Texas, Florida, Georgia, South Carolina, and North Carolina are experiencing rapid population and job growth. New York and California, on the other hand, are experiencing significant population loss and job loss. Yet most REITs-especially ETFs that have multiple REITS-will still give you exposure to those markets that are not positioned to do as well. As an investor, wouldn’t you want to put your chips into the pot that represents the better hand?

Access to Deals Earlier in the Life of the Investment

 

It’s not uncommon for a REIT to be the end buyer of a private real estate deal. However, an investor in that REIT may think they are getting access to the same property that the previous investors had, but they would be wrong. By the time the REIT purchases that property, the value has already been squeezed out because REITs typically like to purchase stabilized assets that can pay a set yield to their investors on Day 1. In general, REITs don’t have the systems in place for  large turnaround/value-add projects. Therefore, buying assets that are already producing peak income is a much easier business model that works for them and their investors.

However, with alternative real estate investments, you have the option to buy into private deals and participate in some of the upside, while still earning a similar yield. It just takes a little more work than clicking “buy” on the screen.

Leverage Your Personal Knowledge and Network

 

“Your network is your net worth” is a credo in the alternative investment space. As an investor in a stock, you usually don’t have access to the CEO of the company in which you hold ownership. (Aside from being impractical, that would probably be considered insider trading.) But in the alternative space, you are given “inside information” on your investments readily and regularly, usually on a monthly or quarterly basis. You also have the option to network with other investors, who are a great source for “inside” information.

Your personal knowledge will also play a critical role in your success with alternative investments. Most investors that I meet have some kind of engineering or accounting background, which helps them break down the business model and finances to a micro level and then make sound decisions. Likewise, individuals with a technology background often invest in early-stage tech companies that are related to their own experience. Regardless of your background, the opportunities are endless when you introduce yourself to alternative investments.

If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my bookThe Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways

Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.

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