What are the advantages of alternative investments

Alternative investments are not just a supplement

The collective term alternative investments encompasses various things that are fundamentally different. You have to be aware of which of these fit your own investment goals before you let yourself be guided by promised returns.

If someone is "not liquid" then he has no money. If you say the same thing about an investment, it means that it is difficult to turn it back into cash quickly. Because Latin words sound smarter, one speaks of "illiquidity". Selling a Nestlé share doesn't take a second. At the other end of the range of patience are private equity funds, in which the investor only sees his money again after five, six or more years. If he really needs the money urgently in the meantime, then that is his problem. So of two investments that are otherwise identical, each one will prefer the more liquid one.

Patience pays off

Precisely because that is the case, the less liquid investments must have a return advantage. This “illiquidity premium” actually exists, says Daniel Egger, head of investment at the private bank Maerki Baumann & Co. Institutional investors with a long time horizon can skim off this premium, as can wealthy private individuals who are not dependent on part of their money.

So-called alternative investments include investment products (hedge funds and private equity) and tangible assets such as raw materials, real estate and works of art. In other words, everything that is not a share or a bond is included in this category. It is not surprising that interest in her is currently high. Aligning your investments according to promised returns does not deserve the name of an investment strategy at any time.

The complexity of some alternative investments poses a problem for private individuals who do not have any special specialist knowledge and who do not have the time or inclination to develop it. Eric Steinhauser, head of investment at the private bank Rahn & Bodmer, advises investors to ask themselves whether such investments really meet their own goals and whether the time invested in selecting and monitoring them is worthwhile. Buying a house that you live in is an alternative investment that everyone understands. The same applies to the gold bar that is in the safe. You should only invest in other alternative investments if you have specialist knowledge or if you receive professional advice. Then it can also be ensured that the investment fits the customer and his financial planning. Otherwise there is a high risk that the customer will at some point ask himself soberly whether it would not have been better to keep cash, says Steinhauser.

Not that complex

The idea that you shouldn't buy anything you can't understand is justified. The classification of hedge funds according to how they work is not a secret science either. The book “Alternative Anlagen” by the authors Mostowfi and Meier offers a good basis. The most common strategy is, for example, long short equity. These funds not only rely on rising, but also falling share prices. With this approach it is possible to reduce the risk compared to traditional equity funds.

Managers of such funds seek to buy undervalued stocks and sell overvalued stocks. Of course, this strategy only works successfully if the share prices actually reflect how the company is doing. That is not necessarily the case; in the past, expansionary monetary policy has spurred prices across the board. Share prices moved like ships lifted by the tide. In fact, the high correlation between stocks has made it difficult to make money short selling, says Nicolas Campiche, who heads the alternative investments business at Pictet private bank. That has changed in the meantime. 2015 was a very successful year for those who are also betting on falling prices. CTA (Commodity Trading Advisors) are another category of hedge funds. Put simply, you track price trends in very different markets. No matter how clever software may control the fund, it is mostly based on the basic principle that what rose yesterday will rise again today. Another strategy, called Global Macro, is not based on the analysis of individual companies, but on macroeconomic developments. Campiche is convinced that these two variants should have diverse fields of activity in the future thanks to the expected interest rate hikes in the USA and other measures initiated by the central banks.

For large and small budgets

Direct investments in hedge funds are only possible with sums of millions. For investors whose total assets are below CHF 100 million, so-called funds of hedge funds are the only practicable access to this form of investment. They make investments possible with low five-digit amounts. These vehicles take over the selection of the individual hedge funds. Their liquidity is limited, if not in a very extreme form. At Pictet, for example, redemptions are possible on a weekly or quarterly basis, depending on the fund.

Private equity funds, in which the assets invested are tied up for years, are even more illiquid. These systems are only accessible to a limited group of people because the minimum investment is even higher, usually from a six-digit amount. These funds invest in companies that are not traded on the stock exchange. However, the prices of listed companies would have an impact on the prices of private companies, explains Campiche. That is why it is currently difficult for private equity funds to buy companies cheaply.

Raw materials, on the other hand, are currently considered cheap. But because they don't yield any returns, you have to hit the right time to benefit from rising prices. The chance that a private investor who does not have specific knowledge will succeed in this over a longer period of time is relatively small. After all, the prices of raw materials do not move in step with the stock exchange prices, which is why they can actually contribute to the diversification of a portfolio. Daniel Egger is of the opinion that the opportunities currently outweigh the risks with historically cheap agricultural commodities.

Illiquidity as an advantage?

Private equity and hedge funds, in particular, are often criticized for the fact that the products are too complex, too expensive and, in the worst case, you can never get rid of them. If that were indeed the case, why do the largest investors in the US, foundations with assets of billions and family offices, invest half of their assets or even more in alternative investments? One reason for this is certainly the expertise such investors have. The long investment horizon is likely to be just as important.

How many private investors claim to be investing long term only to panic and sell when a crisis breaks out? Illiquidity can be seen as a disadvantage, but also as an advantage. Looking back, many would have wished that they would have been forced to just sit out a bad year. Freedom of action also means that you are free to sell at the worst possible time. Therefore, because of their illiquidity, alternative investments should not be an afterthought when making investment decisions. If you are really ready to invest in the long term, then you should give them the weight they need.

On the subject


Dossier: Investing in a low interest rate environment