Dec 14, 2021
This is the first post in a series to discuss what’s trending in private equity and alternative investments. Today, we face the unexpected head on.
Approaching the Unexpected
Throughout history black swan events have reverberated across the global economy in costly and unexpected ways. While they’re impossible to time, investors can plan for black swan events. In times of crisis, private assets with low correlations to public markets provide downside protection, while riskier assets provide growth potential. Experienced and institutional investors typically seek exposure to both public and private asset classes to keep an even keel. This approach has returned steady gains over time and can be particularly useful today.
Using history as a guide, we will review different approaches that succeeded in the past, and how to face the unexpected with a blend of time-honored and newly accessible investment strategies.
From 1918 to 1919, the Spanish flu caused an estimated 25 to 50 million deaths, upending daily life while propelling newer and non-correlated market segments forward. During this period, investors with alternative asset exposure to art outperformed. During the world’s most recent black swan event -- the Covid-19 pandemic -- investors have observed a similar outperformance. Why?
In a world of instantly interconnected commerce, diversification matters now more than ever.
Diversifying into private equities and alternative investments like real estate and art can help investors gain low-correlation exposure and offset risk in turbulent times. For an asset class that has averaged returns of 10.48% from 2000 - 2020, it's easy to see why interest in and exposure to alternative investments has increased recently -- the risk-adjusted price is right.
While private equities have long outperformed public equities, assessing cross-asset performance has been difficult. Savvy investors often look to internal rates of return (IRR) to evaluate investability across asset classes. The higher the IRR, the greater the potential for payout. So, when IRR remains high despite uncertainty it would be common opinion to assume that market participants have priced in risk.
Although past performance does not indicate future valuation, identifying trends can help investors find their footing in a world in flux.
In 2021, Securitize saw a variety of private equity trends take place on our alternative investment platform. Shortly after the latest Covid-19 “variant of concern,” Omicron, hit, Securitize saw alternative asset volume pick up as investors traded securities across primary and secondary markets. Moving into late 2021, we see a risk-on sentiment developing as well.
These insights are made possible by our digitally native platform that provides unaccredited, accredited, and institutional investors the data and optionality needed to face black swans with confidence.
Facing Black Swans
While black swan events like the coronavirus cannot be timed, they can be anticipated using different financial instruments.In public markets, accredited and institutional investors often hedge against negatively anticipated outcomes using equities, futures and options. For example, owning the underlying asset and opening a put or call option on its future valuation can offset potential losses.
This sophisticated strategy minimizes downside risk while maintaining price exposure to the underlying. But not all trading venues are created equal and not all asset classes can be hedged in the same way.
Balancing Unequal Parts
Hedging usually requires the optionality to place bets on both sides of a trade. In mature public markets like the United States, liquidity is deep and futures options are cheap. In less liquid private markets hedging is difficult but, as we’ve seen, the reward often outperforms.
To balance these unequal parts, Securitize developed the first end-to-end alternative investment platform for digital asset securities. As a FINRA member broker-dealer and the first SEC-registered transfer agent operating with digital asset securities, Securitize provides seamless access to private capital raises, primary markets, and secondary trading all from one compliant venue.
Providing Portfolio Ballast
Like ballast steadies boats in a storm, alternative assets can keep portfolios performant in times of uncertainty. These days alternative assets include digital assets like bitcoin, as well as digital asset securities such as tokenized funds or equity in private companies. According to Yale economist Aleh Tsyvinski, a 6% allocation to bitcoin can improve overall portfolio performance. But putting bitcoin to work has been historically difficult.A major hurdle facing institutional adoption has been operationalizing compliant custody.
Strict fiduciary rules mean institutions seeking digital asset securities exposure will need to first find a trusted provider. Fortunately, they can find peace of mind and a convenient way to hedge overall portfolio performance with Securitize.
For accredited and institutional investors seeking actively managed financial instruments, our Bitcoin Yield Fund brings the ability to securely earn yield from the best performing asset in modern history. Yielding 2.84% APY since the fund’s inception in late July 2021 through late December 2021, this fund is designed for those with a high risk appetite looking for annual return potential.
For investors looking to hedge uncertainty via alternative assets like private equity, Securitize offers a number of low-fee options as well.
Outpacing Slippage in 2022
As we move into the latest stage of the Covid-19 pandemic, achieving risk-adjusted returns will become more difficult using traditional tools. The slippage between price and earnings will increase as distortions to the underlying economy reverberate across public markets. And smart money will look elsewhere.
Looking out to 2022, institutional and experienced investors should keep optionality top of mind. As we’ve seen, hedging a possible downturn in public markets with a small allocation to digital asset securities or private equity can improve overall portfolio performance.
While we can’t time it, we do anticipate that inflows into private equity will continue into 2022 as investors search for yield in a topped-out public market. Moreover, we believe that allocating a percentage to alternative assets can act as a hedge in volatile times.*
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.