There is currently some $6.2 trillion held in alternative investment classes worldwide. And if 2020 has taught us anything, it’s that you never know what’s going to happen in traditional asset classes, like stocks and bonds. One international event can change everything.
We’ve seen that in different places across the world. For instance, at Savant Capital Management, clients moved 10-20% of their portfolios into alternative investment strategies as a result of the COVID-19 pandemic. Preqin, a research firm, surveyed investors and found that while short-term strategies may change, investors ultimately believe that COVID-19 won’t have a long-term impact on how they invest in alternative asset classes.
This may provide some momentum for people who are looking into alternative investment classes. But not every investment strategy is alike. Some alternative investments may see success—but others may be in trouble. What will 2021 bring? Which alternative asset classes will get hit hardest? Which will represent the biggest opportunities? Here’s a brief forward-looking guide to alternative investment classes in 2021 and beyond:
How COVID-19 Affected Investor Behavior
In a Mercer report on how COVID-19 impacted investor behavior—especially as it relates to alternative investment classes—there were some interesting trends:
- “Dry powder.” Cash became king in 2020, with private equity firms “sitting on a record $2+ trillion of dry powder,” equipping them for potential future cash deployment whenever an obvious opportunity came along. In other words, investors moved to cash—and quickly. This keeps a substantial amount of money on the sidelines.
- Disruptions in real estate. COVID-19’s effects have hit real estate in interesting ways. Solovis sees “greater risk premiums” applied to real estate. The Federal Reserve Bank of St. Louis also saw a major impact, noting the “COVID-19 pandemic significantly affected the U.S. residential real estate market during the spring months.”
- As the St. Louis Fed noted, buyers reduced home-buying activity in the immediate aftermath of nationwide shutdowns. Said the Fed: “Home showings per listing in the U.S. were down over 40% in April compared with the same period last year.” However, charts also point to a fast recovery in home sales.
- In that case, it’s important to remember that real estate as an alternative investment class is a massive category in itself. What happens in commercial real estate may not happen in residential real estate.
- Real estate set to boom in 2021? Looking back at the Preqin survey, it’s clear that alternative asset investors don’t see massive long-term changes as a result of COVID-19. As Forbes noted, housing prices had momentum before COVID-19. In 2020, it also noted some areas in which 5-6% increases in home prices showed an increase in demand.
- Given that momentum before and through 2020, residential real estate continues to show legs. Combine that with the confidence of alternative asset investors that COVID-19 won’t change long-term investing habits, and residential real estate appears to have a solid footing for the post-lockdown environment.
- Hedge funds. A market collapse back in March was a highly disruptive event. Yet there was one hedge fund that posted a 3,612% return: Universa. The hedge fund works with Nassim Taleb, author of “The Black Swan: The Impact of the Highly Improbable,” and posted its massive returns when a classic Black Swan did shake the markets.
- In this case, it’s important to remember what a Black Swan is for investment purposes. Investopedia defines it as “an extremely rare event with severe consequences. It cannot be predicted beforehand, though after the fact, many falsely claim it should have been predictable.”
- When Black Swans hit, they can have a lingering effect on investor psychology. Consider the 2008 financial crisis. Two key factors: “regret” and “loss aversion.” Simply put, the mistakes investors made leading into a Black Swan can have a bounceback effect on investor psychology: they tend to overcorrect the other way, drastically reducing their tolerance for risk.
Which Alternative Investment Classes Will Be Hit Hardest?
Given what we know about investor psychology and the impact of COVID-19, what are the alternative investment classes that could struggle the most after COVID-19? Let’s look at those asset classes with clear short-term risks:
- Venture capital and startups. As the Mercer report noted, “From a sector perspective, consumer-related startups may experience the largest negative impact in the short term whereas enterprise software companies should fare better.” What does this mean? If more investors keep cash on the sidelines, venture capital could potentially be in shorter supply. Risk-averse investors typically don’t make major investments in venture capital and startups in nervous situations.
- Risk in commercial real estate. Commercial real estate may be one of the hardest-hit classes of the entire COVID-19 pandemic. Telecommuting increased during the pandemic, including remote workdays “doubling”. The result? More companies are comfortable with remote work, decreasing demand for commercial real estate and office buildings.
- Energy. Energy spans multiple asset classes, from traditional large-cap stocks to private equity investments. But one impact of COVID-19 was clear: the demand for oil took a sharp dive. At one point, the price of a barrel of oil was in negative territory. Oil prices have remained low for the duration of COVID-19, even though they’ve recovered against the price shocks earlier in the year. One thing is clear: as long as social distancing and remote work orders remain in place, demand for oil will generally remain subdued, affecting energy throughout both traditional and alternative investment classes.
Which Alternative Investment Classes Might Succeed After COVID-19?
One to watch here: precious metals.
Gold and silver are seen as “safe haven” investments that provide additional financial security that diversifies out of other “security blankets” like cash and bonds. Investors often turn to gold and silver when there are highly uncertain geopolitical events rocking the world.
Investors did as much during the COVID-19 pandemic, as the price of gold soared. Even earlier in the year, the U.S. Mint sold more ounces of American Eagle gold coins than it did in all of 2019.
On December 31st, 2019, the price of gold was about $1,523 per troy ounce. It hit a new all-time high in August of 2020 at the price of $2,067. The price of gold hovered in the $1,900-$2,000 range. During a rocky U.S. election week, gold prices once again soared, moving from the $1,880 range back into the mid-1900s.
One potential reason investors flock to precious metals is declining faith in the U.S. dollar. The U.S. national debt continued to increase throughout the COVID-pandemic, with high-spending measures such as economic stimulus passing through Congress. Many precious metals investors believe this is good for the asset class.
Another unusual investment class that seemed to perform well during COVID-19 was that of unlisted infrastructure funds. One data firm even saw that these funds raised $38 billion during the first quarter, the third-highest total on record for the sector.
“Investors seem keen to commit money to infrastructure,” said Institutional Investor. “Just under a third of investors surveyed by Preqin said they planned to commit between $100 million and $499 million to the asset class over the next 12 months.”
Where the World Goes From Here
No investment asset class is immune from risk. Stocks—which generate traditionally high returns—also have associations with volatility. An individual real estate property might generate solid returns, but it’s subject to the economic conditions of its location.
That means it can be difficult to predict where the world goes in a Post-COVID world. However, there are some things worth noting.
Philip Palumbo of Palumbo Wealth Management sees some problems with stock investments as a whole, over the next decade. Said Palumbo: “I think returns for stocks will be below historical norms for the next 10 years…Today is similar to the period in the markets right after the tech bubble blew up in 2000, and for the next 10 years alternatives beat the public markets.”
Palumbo Wealth Management isn’t the only organization seeing reasons for optimism in stocks. JPMorgan expects another short-term surge in stocks by early 2021, looking for an approximate 11% gain. In a longer trend, JPMorgan sees the Federal Reserve’s “supportive monetary-policy stance” as a reason to believe stock valuations will remain high in 2021 and perhaps longer. BusinessInsider points to “value stocks beaten down by the coronavirus pandemic” as a source of optimism in the future. Alternative investment classes similarly “beaten down” by COVID-19 may enjoy a similar outlook.
If that’s the case, it may be that alternative investment asset classes will see more enthusiasm over the next decade. What that means specifically for the price of gold, real estate, and private equity investments is difficult to predict. But there are some areas in which alternative investments may be more predictable than even traditional investments. Commercial real estate, for example, may be fundamentally changed by an increasingly digital world.
We can’t make any predictions, but we can observe where the needles are pointing us. In the case of COVID-19, some asset classes may help investors feel more secure about their portfolios—while others may appear ripe for avoiding.