A Comparative Guide to Alternative Investment Opportunities for Holistic Wealth Management
One of the key drivers of the boom in wealth management has been the rise of alternative investment funds (AIFs), essentially either structured products, cryptocurrencies, thematic funds, real estate funds, private debts, and other such, where HNIs make sophisticated bets on new investing strategies, unlike the conventional world of mutual funds that are used by millions of small investors.
Alternative investments represent approximately $13 Tn (or 12% of the global investable market). By 2025, the industry is expected to grow to $20 Tn — $25 Tn (18–24% of the global investable market). India’s alternative investment industry has grown by nearly 265% since 2017. But the industry is still underdeveloped relative to the rest of the world. As of June 2020, the industry is estimated at $54 Bn in India. The recent growth of India’s alternative investment industry can be highlighted by two recent developments. First, India’s private equity space took the spotlight when Reliance Jio raised $20 Bn via notable blue-chip investors and tech giants, despite the global Covid-19 outbreak.
A Camaraderie of Risk and Opportunities
An investor who is looking to diversify the investment risk in various asset portfolios. An ideal investor will be the one who is willing to take the underlying risk involved in these unlisted and illiquid securities. Usually, Resident Indians, NRIs, PIOs, OICs, and foreigners are eligible to invest in various types of alternative investments.
Structured Products
These are financial instruments consisting of three components:
a) A Bond
b) Multiple Underlying Assets
c) Derivatives
Depending on the investment objective of the structured product, the interest generated by the bond component is used to buy the derivatives. The underlying asset helps generate the return component. The derivative is of paramount importance in the construction of a structured product. Most of the time it is what determines the level of return. The choice of derivatives will depend on the:
a) desired risk level for the product (capital protection or not),
b) preferred investment horizon,
c) type of return and exposure sought, and market conditions
In the current time, structured products seem to be appealing for customers who try to optimize and diversify the portfolio of savings and achieve the target returns. But with a change of generation, the future holds place for investors moving for fast-paced money-making opportunities rather than the traditional buy and hold investments. The risk with structured products is the lack of liquidity that comes along with low returns and it can be considered more as a buy and hold investment. Along with the lack of liquidity, the potential loss of 100% principal is a huge risk involved.
Cryptocurrency
Cryptocurrency is a digital currency that can be used to buy goods and services but uses an online ledger with strong cryptography to secure online transactions. The highlighting characteristics of cryptocurrencies are:
a) Decentralized
b) Volatility
c) Trust-less
The global market of cryptocurrency in 2019 was approximately $792 Mn. The market is expected to grow at a CAGR of 30% and have a market capitalization of around $5100 Mn by 2026.
One of the most notable acceptors of cryptocurrency as a viable medium of payment is Apple Inc. PayPal, Starbucks, and Coca-Cola are amongst the other giants accepting cryptocurrencies.
It is also one of the most lucrative investment options currently present. Its value appreciation is supremely dynamic and can prove to be an excellent avenue for capital expansion.
When it comes to cryptocurrency, the investor sentiments are at an all-time high currently. The biggest risk involved in cryptocurrency is the threat of cybersecurity including malicious activity. Loss or destruction of the private key will lead to a 100% loss of principal.
Overall, it is wise to place your bet on crypto in the coming era, keeping in mind that there might be periods of underperformance from time to time.
Thematic Funds
Thematic Funds are equity mutual funds that invest in stocks tied to a theme. Currently, SBI Magnum COMMA Fund and Aditya Birla Sun Life MNC Fund are the most popular thematic funds in India. The idea is to concentrate on making a portfolio with one core element of the economy. Exposure in different sectors helps to partially diversify the risk. It is less risky than sector-focused funds.
The practical application of thematic funds can be seen as wealth managers create different portfolios as per the theme that the investor wants to focus on. For example, outdated industries use more suitable examples like fintech, supply chain, or SaaS.
However, if you are a very conservative investor, you may not consider investing as these funds come with higher levels of concentration risk. You must have an investment horizon of at least 5 years to mitigate the associated risks.
A mid to long-term investment trend should underlie the investment rationale behind thematic funds. Let us understand how thematic funds are a good investment with an example. Due to Covid- 19, we saw a boom in the healthcare, pharmaceuticals sector. Considering the Covid-19 is going to stay a bit longer than expected, there will be an increasing demand for healthcare.
Thematic funds should concentrate more on investing in the specific companies which stand to benefit from this boom- like healthcare, pharmaceuticals, medical instruments manufacturers, etc. Similarly, hybrid and electric vehicles might be the road runners for tomorrow. So accordingly, thematic funds would look forward to investing in those specific sets of companies. Ideally, thematic funds should constitute 5- 10% of your portfolio if you are an aggressive investor willing to take higher levels of risk.
Real Estate Funds
A real estate fund is a sector fund that invests in securities of companies that invest in real estate projects. Investors get broad exposure to real estate for a low investment level. A Real Estate Fund can comprise investments either directly in real estate companies or in Real Estate Investment Trusts.
Some of the characteristics of real estate funds are:
a) Long term investment
b) Returns depend on the growth of the sector
c) Liquidity to investors, which is not the same if invested in physical real estate
With inflation on the rise, the prices of properties will increase which in turn will increase the value of real estate making it a protected investment for the investors willing to invest their money into long-term investment plans for at least 5 years. And the people who are in search of quick returns might not fit as suitable investors for these funds. Overall, they are being seen in a more traditional light, due to new opportunities. Present case on their growth opportunities and are they still relevant post covid.
The two common risks with these funds are the market risk of the real estate sector and the interest rate risk. Retail investors have a large amount of disposable income so investors like them can consider real estate funds for a diversified investment portfolio.
Private Debts
A private debt fund specializes in lending activity and raises money from investors and lends that money to companies. It represents an alternative to bank lending as well as providing investors with exposure to the more bond-like returns occurring from private debt as an asset class.
Private debt funds come in different shapes and sizes. For example, some private debt funds provide capital to sponsor-backed borrowers, others fund real estate development projects, and some invest entirely in the debt of distressed companies. By 2019, the assets invested into private debt reached a record high of $812 Bn and it was expected to exceed $1 Tn by 2020 but for the Covid-19 outbreak which slowed it down.
Private debt in Europe has grown by nearly 380% in the past decade and the Asian market has taken off in recent years. The lower volatility and regular cash income are really attractive to investors. Already one of the fastest-growing alternative asset classes, with total AUM rising 168% from $315 Bn in 2010 to $845 Bn in 2019, this growth is expected to continue with a 73% increase in AUM to $1.46 Tn by 2025. It is thus expected to become the second-fastest-growing alternative, next to private equity, by 2025.
The Journey Ahead
The future of the alternative investment industry seems likely to be one of both growth and significant structural change, accompanied by an increasing maturity of the industry’s infrastructure, regulation, and investment relationships. The importance and need of the alternatives industry are likely to become even more evident to the public as individuals begin investing in the sector through retail alternatives, to strengthen the value of personal long-term investment portfolios. Ultimately, demonstrating the value addition that the industry generates and doing so in a transparent fashion will be the key to the industry being accepted by the public and policymakers. The Indian Alternative Investments Market still represents a minuscule share of the global market and is poised for unprecedented growth in the years to come.
This article has been co-authored by Yogesh Lakhotia, who is in the Research and Insights team of Torre Capital.
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