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What Are Alternative Assets?

Preqin

- 15 min read

Introduction to Alternative Assets

Alternative assets typically refer to investments that fall outside of the traditional asset classes commonly accessed by most investors, such as stocks, bonds, or cash investments. Due to their alternative nature, these investments may be less liquid than their traditional counterparts and may require a longer investment period before any material value is realized.

Explore each definition of the asset classes within alternative investments by clicking on the images below:

Traditional vs. Alternative Investments

Traditional investments are publicly traded investments in stocks, bonds, or cash. The traditional method of investing is via public markets, where companies sell shares to the general population via stocks exchanges, such as the FTSE, NYSE, and SSE. These types of investments are heavily regulated by financial authorities such as the SEC (Securities Exchange Commission) or the FCA (Financial Conduct Authority).

An alternative investment is a financial asset that does not fall into one of the three traditional investment categories. Alternative investments are complex and not heavily regulated. For this reason, most alternative asset investments are held by institutional investors or accredited, high-net-worth individuals.

Due to their lack of regulation, private markets are notoriously opaque compared to public markets. For example, private companies are under no obligation to reveal earnings or financial information, or report to shareholders, which means that information on these types of assets can be hard to find. This is why Preqin exists: to bring transparency and facilitate understanding across alternative assets with comprehensive data and best-in-class analytical tools.


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Relative Size of Alternatives vs. Traditional Investments

According to the Securities Industry and Financial Markets Association (SIFMA), the global equity market capitalization reached $95tn while the outstanding value of the global bond market reached $105.9tn by end of 2019. According to Preqin data, the alternative investment markets reached $10.89tn during that same time period, although other estimates reach north of $13tn.

What Are the Characteristics of Alternative Investments?

The table below examines some of the key differences between traditional investments and alternative investments:

Traditional Investments
Alternative Investments
Liquid investments
Largely illiquid investments
Numerous and passive owners
Active owners
Highly regulated
Less regulated
Extremely correlated with, and sensitive to, market movements
Low correlation to public markets
Generally do not use leverage
Use of leverage
Positions are typically held long-only by retail investors, meaning that investors profit when prices rise, though many investors can short traditional investments 
Can take short positions, allowing investors to profit when prices decline
Low investment amounts allowed
High minimum investment requirements
Open to general public and accredited investors
Only open to accredited investors
Liquidity
An illiquid asset is one that is difficult to sell or exchange for cash compared to stocks and shares, which can be sold on the open market with relative ease. Alternative investments generally impose limitations on withdrawals ('lock-up periods' – discussed below) and have higher minimum investment thresholds, with few investors willing or able to purchase part, or all, of the asset at any given time.

Examples of illiquid assets:

  • Property
  • Art
  • Infrastructure
  • Debt (long-term, corporate bonds, municipal bonds)

Alternative investment funds will usually stipulate a lock-up period, during which the invested capital cannot be liquidated. Lock-up periods vary: for hedge funds it may be anything from 30 days to one year, but in the case of private equity or real estate investments, lock-up periods will often be 10 years or more. There are two main types of lock-ups:

  • Hard lock-ups: an investor cannot withdraw their capital within the specified time period.
  • Soft lock-ups: withdrawals of capital are allowed, subject to a liquidity fee.
Passive vs. Active Owners
In traditional or public markets, owners tend to take a passive approach to the assets in which they invest. For example, a member of the general public could purchase shares in a company on an exchange, effectively meaning that they own a small stake in that organization. However, the shareholder will likely have no influence or involvement in the day-to-day operations of that company.

In alternative or private markets, this is different. Investors will typically take a much more active role in the management of the company or asset in which they invest, actively working toward growing its value.
Institutional and Accredited Investors
Alternative investments are typically only available to accredited individuals or institutional investors – but what does this mean?

An institutional investor is an organization that makes investments on behalf of its members. Types of institutional investors include pension funds, endowment plans, foundations, and insurance companies.

An accredited investor is an individual with a net worth of over $1mn, or an entity or organization with assets valued at $5mn or more. An individual that does not meet the financial requirement can also qualify if they can demonstrate education or job experience to imply sufficient professional knowledge of unregistered securities. These investors are able to purchase securities that may not be registered with financial authorities, subject to meeting certain requirements.

How Is the Industry Structured?

The alternative assets industry has evolved over time to include a multitude of different industry participants: investors, fund managers, investment consultants, and a range of other service providers. Key industry players include:


  • Asset Owners/Institutional Investors/Limited Partners
Asset owners are the source of capital for investment in alternative assets. Below you will find definitions for some key investor types within alternative assets:



Asset owners make capital commitments to funds, undertaking due diligence to determine which fund managers to invest with. This can be an extensive process, with many stages including quantitative and qualitative due diligence, an assessment of fund manager performance track record and legal due diligence.


  • Asset Managers/Fund Managers
Asset/fund managers are responsible for investing and managing asset owners’ capital. A portion of invested money will belong to the manager, but the majority belongs to investors. The managers generate fees from investors in the form of a management fee and a performance fee that rewards them for strong performance. We cover fees in more detail during a later lesson called 'Private Capital Fund Terms'.


  • Investment Consultants/Gatekeepers
Investment consultants assist asset owners with the management and planning of their investment portfolio and provide investment recommendations. They charge a fee which is often not linked to the profits generated by their recommendations.

Technically, investment consultants are service providers; however, in some circumstances, they can decide where to invest an asset owner’s money. For this reason, they are often referred to as ‘gatekeepers’ and are key to securing capital for many asset managers.


  • Service Providers
‘Service provider’ is the collective term used to describe the parties that provide services to a fund. The main types of service providers include:

In this lesson, we explored what alternative investments are, which asset classes are covered, and how these differ from the better-known traditional investments within public markets. Now you know the characteristics of alternative assets and who invests in them, as well as how the overarching industry is structured across asset managers, investment consultants, and service providers.