Growing up I had a passion for listening to 80’s pop music. But not everyone liked being part of the crowd and so “alternative music” was born and became a thing. It seemed so much “cooler” (80s slang) albeit a bit “darker” than pop as the artists brought out the wilder side of music back then. It was different and different somehow seems more exciting and mysterious, but different is not always properly understood or appreciated.
A little like today in the investment space, traditional run-of-the-mill investing is familiar to the crowd, but the appeal and mystery of alternative investments are certainly gaining traction.
A common perception of alternative investments is that they tend to use complicated investment structures, calculations, methodology and assumptions and hence require much more understanding before venturing into this asset class. Things like derivatives, warrants, futures, contracts for difference, exchange-traded notes, and cryptocurrencies, to name but a few, are what typically pop into people’s minds when they consider “alternative investing or alternative investment funds”.
My first exposure to an “alternative” investment was back in the 1990s when the company I worked for decided to put a hedge in place on their funds to protect losses for investors. Basically, like taking out insurance to protect against an “unforeseen event”, the hedge structure had an additional cost for investors but seemed to do its thing. The hedge worked and limited losses for investors at a time when stock markets fell.
Then I witnessed the other, less impressive side of the alternative investment space. Around the same time, a new investment fund was launched with a ton of fancy structures, protections and mechanisms all geared to try and help prevent loss of money for investors. Of course, markets tumbled, things “that were not supposed to happen” happened. When investors wanted to redeem their money and exit the fund, they were prevented as the fund had several liquidity issues and could not meet its liabilities.
These days, with a perceived lack of performance by traditional investments, the retail investor is getting increasing exposure to what is being classified as “alternative investments”.
For many investors, the allure of alternative investments lies in the perception that one can make a lot more money in a much shorter time than through traditional investing. At a time of a global pandemic, a war in the Ukraine and high unemployment, it’s little wonder that investors are taken by reports of the speed and size of returns generated by alternative investments, but they seldom grasp all the risks involved.
As such, investors tend to focus on the attention-getting headlines highlighting the many scams and horror stories of people losing millions of rands (even billions) after venturing into alternative investments.
The travesty here is that the concept of “alternative investments” gets a particularly bad reputation. Understandably, a lack of understanding of what kind of investments are included in this “hodgepodge” classification is problematic for separating the proverbial wheat from the chaff.
In truth one first need’s to understand what is meant by the rather subjective term alternative investments. To me alternative investments are simply the introduction of new asset strategies and new asset classes into a more accessible space for investors. But now we need to start making some important distinctions in this aggregation of strategies.
There is absolutely no doubt that several of these strategies on offer to the retail space are the product of what economist Mariana Mazzucato terms “casino capitalism”. These are investment products or alternative assets that may or may not make money for the individual (as with gambling), that most decidedly make money for the financial services industry, and that add little true value in terms of using one’s savings to stimulate value in the broader economy.
But "alternative investment" products can play a vital role in society. ETFs (Exchange Traded Funds), for example, were once thought of as “alternatives”. And yet by providing low-cost, easy access to practically anyone with a bank account, they now make investing affordable to the masses. Section 12J funds were introduced to stimulate much-needed retail investor support of small entrepreneurial businesses or businesses with an impact agenda.
The challenge for us as advisers and for retail investors is to know how to identify the difference between the various dynamics. More importantly, how do we help investors understand what to expect when it comes to alternative investments.
Here then, are some useful tips to keep in mind to get off on the right foot:
- Is the investment regulated: What are your rights and are you protected if things go wrong?
- How liquid is the investment: How quickly can you get your money out or can you even get it out? What are reasonable expectations of time frames for investment?
- How tangible is the investment: Can you physically touch it or see it like a building or a company or does it exist in cyberspace like Bitcoin?
- What kind of value does the investment provide and to whom: Does the investment significantly contribute towards enhancing your unique investment objectives and outcomes? If not why invest in it? Are the providers of the investment benefiting way more than you? Where does the value lie in relation to the risks, uncertainties and costs you will incur?
- What is the upside vs the downside – don’t only focus on the returns but ask about the losses. Some alternative investments have generated returns of over 50% in a year only to follow it up the next year with a 100% loss.
- My general rule: If you don’t understand it, only invest a little in it. The more you understand, the more you can risk. Understanding applies to risk, not just return.
- And finally, if you want to gamble, just go to the casino. At least you can get a drink and entertainment there too.
Gareth van Deventer CFP®
OUTvest is an authorised FSP. Views expressed in this article is that of the financial adviser and not a full representation of OUTvest’s stance. All investments are exposed to risk, not guaranteed and dependent on the performance of the underlying assets. Both Exchange Traded Fund(s) (ETF) and unit trusts are collective investment schemes, however, these products are priced and traded differently. A unit trust is priced once a day whereas an ETF is trading continuously throughout the day during JSE trading hours. Ts and Cs apply.