What do people mean by "Alternative" Asset Classes?
Let's start with some definitions:
Asset
An asset is something that people own either wholly or partially, which they either hope will increase in value over time (so it can be sold for a profit). This is called "capital growth" or "equity". Or that ownership will entitle or enable them to get some sort of regular payment or provide some kind of revenue stream. This would be called "yield".
So some examples are, you buy a house and rent it out (hopefully provides both of these). Or perhaps you buy a business, which again you'd hope provides profits along the way. Assets like gold do not provide an income so you are just hoping for capital gains usually with that.
Assets that provide a higher yield will usually be worth more, so if you can increase the yield of the asset while you own it, you might also get some capital growth as well.
Asset Class
A class here just has the normal definition, meaning a category of similar or related things. So an asset class might be something like "property" or "antiques".
Traditional Asset Classes
Traditional assets are things like:
- Property
- Stocks
- Bonds
- Precious Metals
These are the most commonly bought assets in the global market.
Alternative Asset Classes
So alternatives to these are things that are still assets yet are not in the main bracket of commonly held assets
- Art
- Antiques
- Collectibles
- Whiskey or Fine Wines
- Race Horses or Show Jumping Horses
- Crypto Currency
And so on.
Properties of assets
You can get a wide variation in the performance of different asset classes, and even assets within an asset class. So there is no "best" option, rather that each class offers a different profile of risk to suit each investor.
An investor looking for a low-risk approach would find a higher risk asset class less appealing, whereas an investor with a high risk appetite might find low risk asset classes less appealing, as an example.
Let's look at some of the key properties of assets before diving into a comparison of traditional and alternative asset classes:
Correlation
Correlation is a mathematical term used to compare two related quantities. If they both change in a consistent way, they are said to be "correlated". Literally the derivation of that word comes from "co" meaning "together", and "related" meaning just the normal definition of that word.
There are 3 main types of correlation in maths:
- Positive Correlation
- Negative Correlation
- Uncorrelated
So positive means, if one quantity goes up then so does the other one. For example, if you are paid hourly, then the more hours you work, the more you get paid. So time input is positively correlated with your pay.
Negative is the other way around. If one quantity goes up, the other goes down. So for example, The more money you waste, the less wealthy you become.
Things that are uncorrelated have no direct relationship. For example, the amount of time spent working on a business vs how much money it produces. Some people can spend enourmous amounts of time and not make any money, whereas others can spend comparatively less and make much more. There are also people who spend a lot of time and also make a lot of money. So this tells us that time and effort is not the only variable that contributes to business success.
Asset Correlation
You will often find different assets either positively or negatively correlated. For example, a lot of technology stocks are positively correlated. This is because they all benefit from the same conditions within the economy, so when those conditions occur all tech stocks receive a boost or decline in their value. For example during covid, because people went traveling less and spent more time online, tech stocks all went up and airline stocks all went down.
You will find also negative correlations, for example oil prices and airline stocks. When oil prices rise, airlines become less valuable, because all airlines have fuel as one of their major costs, so higher fuel prices means less profits for them.
Since all airlines are affected in the same way, their prices will all be affected by higher oil prices.
The Business Cycle
The business cycle refers to the fact that economies tend to have a 'boom and bust' cycle. This is because assets are often valued based on their perceived future value. In other words, if I believe I can buy something that will sell for $1000 next year, I might be willing to pay up to $900 for it. But if I believe it will sell for $25,000 next year, I would of course be willing to pay much more for it.
So as economies grow and do well, people get the idea that businesses in that economy will become much more valuable due to generating higher profits. This causes stock prices to rise.
People tend to then get over-confident and mistakenly believe asset values will continue to rise indefinitely. This leads them to start paying much more for the asset than it is really worth. People call this a "bubble" because it's like inflating a balloon with a lot of air. Also bubbles are easily burst.
When this gets too high, eventually people will change their minds, and realise that the assets are over-priced, and become less willing to buy them. Then usually some event occurs that "pops" this "bubble". A large company reports a drop in earnings, or a natural disaster occurs.
This switches the tide of opinion, where people start thinking that these companies will earn less money in the future, meaning the asset is actually going to drop in value. As people start to sell, the price of the asset drops further, which breeds more pessimism. People then start to fear for the economy as a whole, and a feedback loop develops that can lead asset prices to collapse.
Eventually asset prices get way too low compared to their true value, and people start buying them again and the entire cycle repeats.
Risk-Reward
Typically you will find that assets are either stable in price or not (i.e. volatile). Assets that are stable don't tend to go up very much, nor do they tend to go down.
Assets that are volatile can go up rapidly but can also drop rapidly, and by large amounts.
You can't really get assets that only have the potential to rise high and fast, without also being unstable. Volatility is always a two-way street.
So if you want to buy an asset that has the potential to grow very fast, you also have to accept the risk that its price could go down fast as well.
Liquidity
This refers to how easy it is to buy and sell the asset and exchange it for some cash. So something like a stock is quite easy to sell, you simply push a button on your trading app and the money comes back to your wallet.
Something like a house could take weeks or months to sell, so is less "liquid". Usually liquidity is determined by the number of willing buyers and sellers. Stocks are liquid because millions of stocks get traded every day so there is always someone willing to buy if you want to sell.
Why invest in alternative asset classes
Different asset classes will typically have a different blend of these properties.
One of the main benefits of alternative asset classes is they are not usually correlated with traditional asset classes.
Sometimes they are negatively correlated. Often when people are afraid of a down-turn in the business cycle, they will start selling traditional assets like stocks (which they believe are going to drop in value) and purchase alternative assets like wine.
If people fear that inflation will be high (i,e. that cash will decrease in value), they may choose to purchase gold or crypto with that cash to preserve their wealth.
Other alternative assets, like horses or other luxury goods, are usually uncorrelated with the business cycle, and completely unaffected by it.
Alternative assets also provide a higher risk-reward profile. You've got more opportunity to out-perform a traditional asset, but to do this you have to accept more risk.
Alternative assets are also usually much less liquid as there are fewer people buying and selling them.
Should I invest in alternative asset classes?
That is not for me to say.
But each investor will have their own goals. Often people earlier in their life are happier to take more risk, as they want to grow their assets. Sometimes people later in life are more interested in preserving what they have.
Some people are keen to get capital growth, whereas others want a steady revenue stream from their investments.
Some people like to specialise and focus on one area like property, others like to diversify and have uncorrelated assets in their portfolio.
If you might need the money soon, then you would be better to buy liquid assets in case you need to sell. If you won't need the money until you retire, then you can afford to invest in less liquid assets.
So everyone has their own goals and preferences. I encourage you to learn and study more about investing to help guide your decisions, or if you want professional help seek the services of a qualified financial advisor.