The Evolution of Alternative Investments
How did the alternative market come to be, and what does the evolution of alternative investments hold for the future?
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What does a tulip, bottle of whiskey, Super Mario 64 and future real-estate development project all have in common?
If you're clever enough to guess from the title of this article that these are all alternative investments, you'd be correct. All of these are — or have been — successful investment opportunities. Each item has rewarded clever investors that dared put their money into non-traditional investments as opposed to stocks or bonds.
How did this alternative market come to be, and what does the evolution of alternative investments hold for the future?
The early days of alternative investing
An alternative investment is loosely defined as any financial investment excluding stocks, bonds or cash-related instruments. Some alternative investments have been around for centuries. The earliest form of commodity trading originated between 4500 BC and 4000 BC. In fact, these commitments with time and date of delivery stipulations closely resemble a modern-day futures contract.
Private art sales date back to Roman times, while the Stockholm Auction House — the world's oldest auction house — was opened in 1674. One of the most popular speculative bubbles in history arose from the trade of rare Dutch tulips during the 1600s. At its peak, bulbs traded for as much as six times the average person's annual salary. As far back as 1787, the writings of Thomas Jefferson have provided early evidence that premiums were charged for older vintages of wine. If we're talking about collectibles, you can't forget baseball cards. Non-traditional tradeables called cabinet cards were produced in the mid-19th century, though the "Golden Era" of baseball cards is said to have started in 1909.
While the alternative investment vehicles above are fun, more traditional and structured financial mechanisms have a much shorter history. The first private family office (The Bessemer Trust) was founded in 1907. Andrew Winslow Jones is credited with developing the first hedge fund in 1940. Less than 10 years later, the first private venture capital firms were formed. Though land ownership and real estate have a rich history as a part of society, the first U.S. REIT wasn't created until 1960.
Rise to prominence
The industry of alternative investments has grown in a multitude of ways. First, more investors and firms are getting involved than ever before. In 2020, a survey of high net worth individuals found 87% were planning to maintain or increase their allocation in alternative assets over the next twelve months. The number of institutions invested in private equity in 2015 was 6,170; today, there are over 8,400 firms involved. Almost 1,800 fund managers hold private debt — over twice as many from just five years ago. Real-estate assets under management rose to a record $992 billion during the summer of 2019 — marking the fourth consecutive annual AUM increase for the industry.
In addition to the volume of alternative investments, history is being made every day in the alternative asset space from single transactions. In July 2021, the $870,000 sale of a sealed copy of The Legend of Zelda broke the record for the most expensive video game ever sold. Two days later, a sealed copy of Super Mario 64 sold for $1,560,000. Also earlier this year, the sale of Beeple's Magnum Opus for $69.3m was the third-highest auction price achieved by a living artist ever. Don't forget about collectible vehicles — the most expensive McLaren F1 ever was sold earlier this year as well.
A hint of devolution
As alternative investments change and evolve, not all aspects of these opportunities are positive. The Tax Cuts and Jobs Act of 2017 removed long-time benefits for collectible investors. The tax law has now banned deductible expenses and like-kind exchanges on collectibles. Intermediaries are also increasing fees in response to rises in demand. Christie's Auction House raised art buyer premiums three times between 2016 and 2019, while Sotheby's implemented a new 1% "Overhead Premium" charge on all sales starting last year. Though used by many as a transactional currency, the law on cryptocurrency calls for capital gains rates up to 20%. The IRS currently holds the position of immediate income tax recognition of staking rewards — even if the cryptocurrency earned has not yet been sold.
In addition, not all areas of alternative investments are continuing to grow. Although hedge funds have rebounded in 2021, roughly 11,600 hedge funds shut down between 2008 and 2020. An estimated $58.76 billion was withdrawn from investors in the industry, with almost $10 billion having been withdrawn from hedge funds in December 2020 alone. Precious metals have also not been performing well as of late. At the time of writing, the price of one ounce of gold had dropped 10.45% from one year ago. Although typically flocked to as an inflation hedge, precious metal prices are feeling pressure due to a stronger than expected job market as well as continued demand for the U.S. dollar.
The age of democratization
We're already seeing what the future of alternative investments looks like, and it's the universal democratization of opportunities. Through the use of technology, investors can avoid high barriers of entry or substantial capital requirements to get involved with assets they believe in. Once limited to certain parties, music royalty investment platforms such as Royal Exchange allow public listings of royalties for sale. Don't have a wine cellar, or are you worried about the physical maintenance of your alcohol investment? Vinovest acquires, stores and ships wine investments. It's currently offering early access to new investment opportunities via its new platform WhiskeyVest. Lastly, non-institutional investors now have access to private equity offers through Republic, a fintech investment platform.
Another evolving trend in the world of alternative investments is tokenization. Tokenization is the act of splitting a rather large investment into digestible pieces for smaller investors. Also referred to as fractionalization, this process allowed "14 Small Electric Chairs" by Andy Warhol to be legally split into digital tokens, with each token representing partial ownership in the artwork. Spencer Dinwiddie, a point guard for the Brooklyn Nets, tokenized his NBA contract — allowing him to collect his three-year contract upfront and allowing investors to have a bond-backed investment of an NBA contract that would pay out over several years. Numerous commercial real-estate marketplaces such as Red Swan require minimum investments of around $1,000; investors can then select between real-estate opportunities across the country to invest in. Whereas alternative investments were previously exclusive, there's now a minimal monetary barrier to entry to own part of something great.
The future of alternative investments
On one hand, alternative investments have been around for centuries. On the other, Barack Obama was sworn in as the 44th President of the United States just 17 days after the Bitcoin network was created. New non-traditional investments are being created every day, building off traditional opportunities with a rich past by incorporating innovative future applications. For the investor looking to diversify their portfolio, it's an exciting time to be a part of this stage in alternative investing's evolution.
Related: The Growth of Sustainable Investing