In our previous article, we provided an overview of alternative assets and made the distinction between alternative investment strategies and alternative assets, or nontraditional assets. This latter category of investments has been available to investors for years, but in large part is mostly illiquid and sparingly used by individual investors (with the exception of gold and real estate) because of the difficulty moving funds in and out such investments. We review a collection of nontraditional assets below and acknowledge the growing attempts to offer more liquid instruments with market exposure to these assets. However, it is our opinion that these assets will ultimately represent a small portion of the overall allocation to alternative investments.
We believe truly investable assets depend on broad markets with multiple buyers and sellers, fairly transparent pricing, and the capacity to settle and enforce the transaction in a short time frame (less than a week). Given those parameters, we think there are limited amounts of nontraditional, investable assets available to a broad client base.
After a brief discussion of each nontraditional asset below, we offer our opinions of the pros and cons of investing in each. In that regard, we define liquidity as the ability to find a ready market in the course of a day or a week, not a month. We define supply as the ability to absorb a significant shift out of bonds and stocks into the nontraditional asset. An asset that can move across borders offers a political risk hedge. An asset offering a hedge against inflation means an asset will move higher in nominal terms to offset a general loss in purchasing power.
Commodities
We define Nontraditional assets to include direct investments in commodities such as precious metals, industrial metals, energy products, and agriculture products. A few exchange-traded funds have been created to hold non-perishable commodities in physical form and some of the most successful exchange-traded funds launched over the past fifteen years offer investors liquid investments in a range of precious metals. We think investors enjoy great liquidity in these funds.
However, offering investment exposure to the many agricultural, industrial and energy commodities traded for ultimate consumption usually requires investors to hold futures contracts (directly or indirectly). In such instances, it is our opinion that holding an on-going long position exposes the investor to the high transaction costs of rolling the futures contracts, and at times, confusion with regard to the linkage between the ‘spot’ price and the futures contract price of a commodity because of supply disruptions and the changing cost of storage and transportation. Our views regarding this widely used, nontraditional asset class are as follows:
- High liquidity
- Inflation hedge
- Low correlation to equities
- Political risk hedge
- Large supply
- Generally low or no income
- Costs for safe and secure storage of physical products
Real Estate
Multi-family residential rentals and commercial real estate have long been staples of institutional portfolios. Individual investors have also enjoyed access to real properties via real estate investment trusts (REITs), so we consider that particular form of real estate to be very liquid. While primary residential real estate has not been broadly offered in liquid units, the entry of various private-equity firms into the ownership and rental of single-family residential units has opened this market to institutional investors, and the possibility of opportunities for individual investors on may be on the horizon.
Timberland, farmland and mineral rights are now being offered more frequently as investable assets but current markets remain very illiquid. We believe that the fixed supply of land makes these assets attractive as long-term inflation hedges—more so than precious metals in our opinion—as land is the source of energy reserves and the key to food and fiber production. Our opinions regarding this widely used asset class are as follows:
- Illiquid core
- Highly liquid in trust form
- Inflation hedge
- Low correlation to equities over intermediate time frames
- Modest supply in investable form
- High current income
- Costs for maintenance and management
Collectibles
Also included among nontraditional investments are coins, art, diamonds, jewelry and other collectibles. Few of these exist in exchange-traded funds in which the investor can purchase participation in a broad selection of underlying collectibles. In addition, forgeries and failed transactions are occasional problems in these highly specialized markets. For the most part, investing in these assets has been the province of the very high net worth client who is willing to tolerate limited transparency and high commissions. Our opinions regarding this nontraditional asset class are as follows:
- High liquidity across borders
- Price discovery and provenance can be difficult
- Inflation hedge
- Low correlation to equities over intermediate time frames
- Political risk hedge
- Very limited supply
- No income
- Costs for safe and secure storage
Venture Capital, Private Equity and Other Illiquid Venture Funding
Venture capital (which we define as an investment in pre-product, pre-revenue companies), private equity (which helps existing companies expand products and revenues), and mezzanine financing also are often labeled as alternative investments because of the low liquidity and private placement method of attracting capital, even though such investments are, strictly speaking, long-only equity.
Investments of this nature are by definition, illiquid at the core. The primary focus of the investment is to provide financing while the business managers either create a product or revamp operations. We could very easily include these among our list of alternative strategies rather than among the list of nontraditional assets. However, given the growth in alternative strategies seems tied to underlying liquidity, it is difficult to see broad distribution of these funds to individual investors given the inability to easily liquidate the underlying investment to meet redemption requests. We believe this type of investment will remain the province of institutions and the high net worth family offices. Our opinions regarding this asset class are as follows:
- High returns from illiquid core
- High returns from innovation
- High ultimate correlation to equities over intermediate time frames
- Limited supply
- Cash calls can require liquidity at inopportune times
Direct Investment in Infrastructure Projects
Funds invested in the capital structure of infrastructure companies (equity, operating company debt, loans collateralized by project revenues) are the traditional method of investing in government spending on roads, bridges, pipelines, dams, etc. Most often, this is done through both private equity funds and shares floated on various exchanges, many in foreign markets. Privatization of convention centers, airports, rail terminals, parking facilities and so forth offer investors the ability to participate in economic growth in regions where the hand-off from government to the private sector can generate significant short-term profits as operators face limited competition.
Increasingly, we believe that many investors are also seeking direct participation in the revenues of various toll roads, ports and terminals. We believe infrastructure projects offer investors an ability to reduce non-domestic inflation risk when investing abroad but are subject to geo-political risks more than other nontraditional assets. Our opinions regarding this nontraditional asset class are as follows:
- High liquidity in the securities of firms providing infrastructure services
- Inflation hedge in emerging markets
- Low liquidity in direct investments
- Subject to political risk
- Limited supply
Foreign Currency Held for Investment
Unlike most nontraditional assets in which the supply available in investable form seems too limited to absorb any significant shift away from stocks or bonds, we believe foreign exchange held for investment offers significant opportunity as a liquid nontraditional asset.
Whereas the supply of land is fixed, for example, the supply of currencies seems virtually inexhaustible. Modern central banking has become, in our opinion, a dominant participant in world market activity and so investors can easily participate in the currency market to source returns not tied directly to stocks or bonds. We expect foreign currency based alternative strategies will become an important part of the alternative landscape. Our opinions regarding this alternative asset class are as follows:
- Extremely liquid in core currencies
- Highly liquid in peripheral currencies
- Abundant supply
- Low correlation to equities
The article above is an extract from our guide to alternative investments available on our website at http://www.larkinpoint.com/guidebook-for-financial-professionals.html entitled Why Liquid Alts Now?
DISCLOSURE
Larkin Point Investment Advisors LLC (“Larkin Point”) is an investment advisor registered with the U.S Securities and Exchange Commission. Registration with the U.S Securities and Exchange Commission does not constitute an endorsement of the firm by the Commission, nor does it indicate that Larkin Point has attained a particular level of skill or ability. Larkin Point is not a registered broker-dealer in the United States. Larkin Point is not registered under the laws of any foreign jurisdiction and this report shall not be deemed a solicitation of any investors or clients in contravention of any such foreign laws and regulations.
The statements and material appearing in this report have been prepared, except as otherwise noted, by Larkin Point, contain confidential or privileged information, and should not be read, copied or otherwise used by any other persons.
This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein.
(c) Larkin Point Investment Advisors LLC
