The world of alternative assets is complex, interconnected, and there are a myriad of considerations for investors to take into account. As an investor you will have decided your own personal investment objectives and to achieve these you will also need to determine a specific portfolio strategy.
Recognising that investment strategies for individual investors will vary widely from lower risk income focused to higher risk capital growth, with many other combinations of this in between, we have outlined below the role that some of the most familiar alternative assets can play in driving investment returns in a diverse portfolio.
Private equity
Private Equity consists of equity and debt investments into companies not listed on a public stock exchange. Very similar to Venture Capital (see below) but generally investments are made into later stage or more mature companies. Private equity firms typically look to invest larger stakes in underperforming companies that have the potential for high growth. Growth in the businesses is delivered by working with the company's management team to improve performance and strategic direction, making complimentary investments and driving operational improvements
Investment Portfolio Role:
Income Return - Low. Private equity investments don’t traditionally represent a strong source of dividends and are more usually long term equity holdings. As such private equity investments are not typically integral to an income investing strategy.
Growth Return – High. Private equity investing is centred around capital growth as private equity managers focus on maximising corporate growth ahead of cash generation and the payment of dividends.
Value Return – Medium. The private equity sector includes a large variety of fund managers each with their own investment mandate and approach to the market. Certain managers focus on value investing by identifying undervalued companies with a view of achieving capital growth.
Venture capital
Venture capital is financing that investors provide to early stage companies that are believed to have high growth potential. Providing venture capital can be risky for the investors who put up the funds but this is compensated by the potential for above-average returns. Investors accessing VC deals are always strongly advised to do so on a portfolio basis so that the high multiple returns from the one or two 'winners' covers the low returns or losses made elsewhere
Investment Portfolio Role:
Income Return – Low. There is little opportunity for income from venture capital investment, given the youth and relative instability of companies that venture capital fund managers support.
Growth Return – High. Venture capitalists, by definition, should be investing in companies with strong growth potential. Given that venture capital looks to invest in very young and unproven companies however, the risk profile is high and as such should be treated with caution. Venture capital investment can provide greater growth returns than private equity investments but at higher risk to the capital invested.
Value Return – Low. The principles of venture capital – high risk, high reward – do not generally match the requirements a value investor, and as such venture capital investments should not be a large component of a value driven investment portfolio.
Start-ups / Seed Stage
Start-ups are entrepreneurial ventures, sometimes described as ‘seed’ stage investments, and are typically fast-growth business that aim to meet a marketplace demand. Startup businesses are generally not yet profitable and frequently have not even started generating revenues. Thus they are very high risk investments with a strong potential for investors to lose all the capital they have invested. The counter to this is that whilst they are very high risk, successful seed stage investments can produce very high returns.
Investment Portfolio Role:
Income Return – Low. Investment into start-ups is very similar to that seen in the venture capital space, and as such will not offer an income stream to investors
Growth Return – High. The opportunity to acquire equity at the earliest stage of a company’s lifecycle can provide strong growth opportunities, particularly in rapidly-moving sectors like technology or digital. Investors should however be aware of the dilutive effect of follow on funding rounds and where possible should be prepared to ‘follow’ their money in order to maintain their level of ownership of the company.
Value Return – Low. As with venture capital, investing in start-ups does not fit well with the value investing mentality of picking under-priced or neglected companies.
Property
Property, in both its commercial and residential forms, is a popular alternative asset and offers attractive benefits in terms of predictable income backed by tangible assets. Traditionally property has been seen as a relatively secure investment.
Investment Portfolio Role:
Income Return – High. Property is the most likely alternative asset to yield strong, sustainable returns for an income investor in the form of predictable rental pay-outs. In high-demand areas the rental market is developing strongly in both residential and commercial areas.
Growth Return – Med. Growth return from investing in property can come from the appreciation of land or property or development of a property asset.
Value Return – Med. Property can be susceptible to valuation bubbles and as such there are opportunities for value investing through the careful selection of under-priced assets or regional variation. Although detailed knowledge and experience is likely to be required, a value approach to real estate can produce strong returns.
Infrastructure
Infrastructure covers any physical assets with a defined commercial purpose. This naturally means that this asset class contains an extremely diverse range of businesses, from solar panels or sewer systems to toll roads or phone lines.
Investment Portfolio Role:
Income Return – High. Investment in an infrastructure fund that seeks to own particular assets outright is the best way of generating income from infrastructure. An investor can generate this income in one of two ways: usage-linked payments such as toll roads depend on frequency and volume of usage, whereas provision-based payments such as hospitals are rewarded for upkeep and quality control. The latter is less exposed to economic fluctuations and is therefore a more reliable income source.
Growth Return – Low. Infrastructure investments tend to be asset based and focused on delivering income returns. Growth is not a key objective.
Value Return – Low. Infrastructure investments would not typically be expected to provide value return unless the asset is being developed or re-purposed.
<Renewables
Renewables are frequently a subset of infrastructure investments. They are companies focused on clean energy technology and are typically the beneficiaries of government backed incentives or tax benefits which can bolster performance.
Investment Portfolio Role:
Income Return – High. Similar to broader infrastructure investing, usage-based models such as power producing assets can provide steady results for income investors, as do dividend payouts from investment in companies specialising in management of renewable energy.
Growth Return – Medium. Longer-term equity investment in renewables can generate capital growth, particularly when investing in smaller tech-based start-ups. Technology innovation across the renewable sector is one of the central drivers of growth investment and can contribute to a growth focused portfolio.
Value Return –Low. At times over the past decade, there have been claims that the market has overvalued aspects of the renewable energy sector, and what value investment opportunities existed were to be found when an overcorrection occurred. Currently there is not a clear value investing approach to renewables.