Alternative Investments of the Ultra-Wealthy in 2023

Why do you think the ultra-wealthy are more likely to hold alternative investments than middle-class or mass affluent investors?

Alternative asset classes are often marketed as being uncorrelated (or having relatively low correlations) with publicly available investments such as stocks and bonds. There is also a suggestion that some of these alternative investments have high returns relative to their risk. Both claims are more controversial than most in the industry would have you believe. Ultimately, I think the allure of alternative investments for the ultra-wealthy is their exclusivity, not the true expected risk-return profile of the investment.

Should most investors consider more alternative investments, like cryptocurrency, luxury items, or direct lending? Why or why not?

Yes, I think investors should consider and investigate alternative investments. However, "alternative" investments are a very diverse bucket. Invest in what you know, what has intrinsic value, or what can provide expected cash flows in the future. If an investor considers Bitcoin as an "alternative" investment, then my answer would be a resounding NO. The purported benefits of Bitcoin are that it is an alternative currency and store of value, yet Bitcoin does not satisfy the conditions that we typically use to classify either a currency or store of value. I have yet to hear a coherent explanation for why Bitcoin will be valuable in 20 years.

Holdings of alternative investments are projected to increase by over 300% between 2010 and 2025. What do you think is behind this significant increase?

There are huge amounts of liquidity in the economy right now and ALL real asset prices are rising. Inflation figures are already above 5% per annum, and there is little evidence that anything is being done to curtail it. Given that, investors would be well advised to have a significant portion of their investments in real assets.

81% of institutional investors are planning on increasing their alternative investment holdings by 2025. Why do you think this is?

Public equities (at least in the US) are extremely expensive right now from a historical perspective, and fixed income yields are also at historic lows. My guess is that many institutional investors are looking to take some of their holdings from expensive public equities or low-yielding debt and put them in alternative investments.

32% of institutional investors are planning on decreasing their allocations in hedge funds. Does this signal a loss of confidence in the hedge fund model?

Hedge funds charge incredibly high fees for what they provide -- in some cases more than 100 times the fees of an index mutual fund. Yet there is evidence that hedge fund investors do not receive any type of superior return for their investments, and likely experience worse outcomes. I think that institutional managers are just finally understanding the empirical evidence. 

Rare whisky, classic cars, wine, and handbags have increased in value by over 100% in the past 10 years. Does this mean more investors should consider investing in luxury items?

Again, investors should invest in what they know, what has intrinsic value, or what can provide expected cash flows in the future. While collectibles have had a great increase in value in recent years, there is a lot of evidence that these returns are incredibly heterogeneous and nuanced. For example, recent research on collectible coins shows that the returns during the 2008–2015 period of MS (Mint State) coins were approximately 4% per year, yet the returns to similar coins graded G (good) were less than -- 5% per year. The same kind of dispersion can be shown for baseball cards, wine, art, etc. If investors are going to put their hard-earned money in collectibles and luxury items, they need to know the particular market that they are investing in well.

Why do you think the ultra-wealthy are more likely to hold alternative investments than middle-class or mass affluent investors?

The ultra wealthy are more likely to hold assets outside of retirement plans which typically have a lot of restrictions. So for many ordinary investors, these asset classes are just not available. For the ultra wealthy, alternative assets can provide higher expected returns, in part because they are much less liquid. But holding illiquid assets really only makes sense for those who have a good proportion of their portfolio already in liquid, traditional assets. High net worth investors can also afford to be more speculative - by definition they already have a lot of wealth, so they can take more risks. 

Should most investors consider more alternative investments, like cryptocurrency, luxury items, or direct lending? Why or why not?

Alternative investments encompass a wide range of products. Real estate and private equity make a lot of sense for higher net worth investors. They tend to be quite illiquid, so should only be held in a portfolio that has a liquid portion - such as traditional assets like bonds and stocks.

My definition of an investment is something that has a fundamental value that we can estimate and that generates some sort of income stream (although that income can be retained in the asset -- such as a stock that doesn't pay dividends). Many alternative assets don't really satisfy this definition, and so in my opinion, many alternative investments aren't really investments. They are just stuff. Whisky, fine wine, art, and baseball cards aren't really investments. They are really more like aspirational items that high net worth investors might like to buy. I wouldn't seriously consider these to be a part of anyone's portfolio, but if someone wants to collect wine or art, then all power to them, but it shouldn't really be considered to be part of an investable asset class.

Cryptocurrency is more of a speculative instrument rather than an asset. Crypto generates no income and is very very hard to establish a fundamental value on, as a result, it's almost impossible to make a judgment as to whether any particular crypto is over or undervalued. With crypto you are just making a bet that it will increase in value, but there are really no fundamentals that can support any particular valuation.

Holdings of alternative investments are projected to increase by over 300% between 2010 and 2025. What do you think is behind this significant increase?

This is largely due to the continued increase in wealth of higher net worth individuals. As more money chases a limited supply of stocks and bonds, investors start looking for additional places to place their money. In addition, alternative investments tend to have much higher fees than traditional assets. They tend to be very profitable for investment companies and advisors and hence are promoted heavily to high net worth clients.

81% of institutional investors are planning on increasing their alternative investment holdings by 2025. Why do you think this is?

Most of them are chasing higher returns. The number of stocks listed in the stock market has been flat, yields in the bond market are very low, so institutions are looking for other places for yield. Alternatives such as private equity and real estate may help in this search.

32% of institutional investors are planning on decreasing their allocations in hedge funds. Does this signal a loss of confidence in the hedge fund model?

Hedge fund returns have really been overhyped for years. Hedge funds are incredibly expensive from a fee point of view and furthermore, buying and selling them is extremely complex. They are basically very expensive investments that in general, don't provide better performance than a diversified portfolio of stocks and bonds. My concern would be that an institution would move from one over-hyped expensive investment to another. 

Rare whisky, classic cars, wine, and handbags have increased in value by over 100% in the past 10 years. Does this mean more investors should consider investing in luxury items?

These aren't investments! They are just expensive stuff that might increase in value. You should buy luxury items because you want to own them and they bring you pleasure. Trying to justify your purchase of a classic car as an investment is basically trying to justify your hobby as something more legitimate!

Why do you think the ultra-wealthy are more likely to hold alternative investments than middle-class or mass affluent investors?

The ultra-wealthy have a higher tolerance for risk; if they lose all of an investment’s value, they still have other resources. If someone in the middle class took significant risks with alternative investments, losses would impinge upon their standard of living. The willingness to take on more risk increases as wealth increases.

Should most investors consider more alternative investments, like cryptocurrency, luxury items, or direct lending? Why or why not?

Definitely not. Cryptocurrency is the Tulip Mania of our generation, so this should be off the table – no matter what you hear about great "profits." Everyone needs to live within their means. Shooting for the stars is fine if you have a significant financial cushion, but otherwise it is not wise.

Holdings of alternative investments are projected to increase by over 300% between 2010 and 2025. What do you think is behind this significant increase?

Worrisome. The mania will end. And predictions are often wrong.

81% of institutional investors are planning on increasing their alternative investment holdings by 2025. Why do you think this is?

Diversification and the search for returns. The returns on fixed income are so low that they are hunting for bigger, better returns, but these come with a greater risk.

32% of institutional investors are planning on decreasing their allocations in hedge funds. Does this signal a loss of confidence in the hedge fund model?

Hedge funds don’t really hedge, but take great risks. This works when the economy is doing well, but doesn’t in an economic downturn. Too many investors chasing too few returns.

Rare whisky, classic cars, wine, and handbags have increased in value by over 100% in the past 10 years. Does this mean more investors should consider investing in luxury items?

Absolutely not. Not only do these have price risk, but there is physical risk to these assets, which would require substantial insurance. Not worth it. Haven’t we learned from Beanie Babies?