81% of Ultra-High-Net-Worth Individuals Use Alternative Investments

9 months, 3 weeks ago - December 15, 2021
81% of Ultra-High-Net-Worth Individuals Use Alternative Investments
Alternative investments are going mainstream.

It's no secret that the ultra-rich have access to alternative investment opportunities that seem unavailable or unobtainable to the average investor, like expensive wine, vintage cars, fine art, equity in private companies, and real estate.

What may come as a surprise is that ultra-high-net-worth investors (those with a net worth of at least $30 million) have, on average, 50% of their assets in alternative investments. And they are likely to allocate even more of their portfolio toward alternative investments in coming years, despite the recent strong performance of major stock market indices.

Before going further, let's define "alternative investment."

Alternative investments are investments in anything other than listed equities, bonds, and currencies. It's a broad term that encompasses tangible assets, like wine, baseball cards, cars, art; and commodities like precious metals, real estate, private equity, private credit; and investments in hedge funds.

Read on to find out how the ultra-wealthy incorporate alternative investments into their portfolios.

Key findings

  • Ultra-high-net-worth investors (those with a net worth of at least $30 million) had 50% of their assets in alternative investments in 2020, down from 52% in 2017. Investors with over $1 billion in assets have more than 50% of their assets in alternative investments.
  • High-net-worth investors (typically defined as those with over $1 million in assets) shifted their alternative investments toward private equity and real estate between 2017 and 2020.
  • Private equity accounts for 54% of the alternative investments managed by ultra- high-net worth investors. Real estate accounts for 22%, making it the second-largest holding in alternative investment portfolios of the ultra-wealthy.
  • Cryptocurrency, another alternative investment, is held by 72% of high-net-worth investors.
  • Total alternative investment assets under management are projected to reach $17.2 trillion in 2025, more than four times the 2010 level.
  • Certain luxury goods, such as rare whisky, classic cars, wine, and handbags have seen their value grow over 100% over the past 10 years.

Ultra-high-net-worth families had 50% of their assets in alternative investments in 2020

Ultra-high-net-worth families had about 50% of their assets in alternative investments in 2020, down 2% from 2017 but still accountable for a larger portfolio share than any other asset class, according to a survey from the global investing firm KKR.

KKR also reports that families with over $1 billion in assets under management -- well above the ultra-high-net-worth cutoff of $30 million -- have invested over 50% of their assets in alternative investments.

It's mostly the ultra-rich that invest in alternative investments.

High-net-worth investors (those with assets over $1 million) allocated 26% of their assets to alternative investments in 2020, up from 22% in 2017.

For comparison, alternative investments make up about 5% of the average investor's portfolio, per a survey from the Chartered Alternative Investment Analyst Association.

While listed equities have been on a tear with few exceptions over the past decade, ultra-high-net-worth investors allocated just 31% of their portfolios to those equities in 2020. Listed equities accounted for 49% of the portfolio's of high-net-worth investors.

The ultra-wealthy's outsized role in alternative investments is also shown by data on usage of those investments.

81% of ultra-high-net-worth clients surveyed by EY currently hold alternative investments, compared to 55% of very-high-net-worth clients, 29% of high-net-worth clients, and just 14% of those defined as "mass affluent."

Private equity and real estate were the only alternative investments to see portfolio growth from high-net-worth families between 2017 and 2020

High-net-worth families gave private equity and real estate larger shares of their portfolios in 2020 compared to 2017, with both notching 3% gains. Those are the largest percentage gains among all assets, including traditional investments.

This group allocated 27% of their assets to private equity in 2020. Only listed equities accounted for a larger share of their portfolio. Real estate made up 11% of their assets, the third-largest share.

Hedge funds saw the largest decline in portfolio shares with a 6% reduction to account for just 6% of the portfolios of high-net-worth families in 2020, while private credit and other real assets also experienced shrinking shares.

Private equity investments by high-net-worth investors are projected to continue to grow.

Bite, an alternative investment platform, predicts 9% annual growth in private equity investments from those investors through 2024 due to technological improvements that will increase ease and efficiency of investing in private equity, solid historical returns, and the desire for diversification.

72% of high-net-worth investors have invested in cryptocurrency

72% of high-net-worth investors have invested in cryptocurrencies, an alternative investment that has at times dominated financial headlines with mind boggling gains and drops in recent years, according to Capgemini, a consulting firm that focuses on digitalization and technology.

High-net-worth investors do, however, face some unique challenges that may be keeping them from investing heavily in cryptocurrencies.

Those investors are accustomed to services that navigate them through complex tax and inheritance issues that come with the territory of having millions, if not tens or hundreds of millions, in assets. Major banks, however, are only beginning to offer or explore such cryptocurrency services for their wealthy clients.

Those services are, in all likelihood, a prerequisite to cryptocurrency composing even a relatively small slice of the average high-net-worth investor's portfolio.

Private equity is the only alternative investment to outperform the S&P 500

Proxies for major alternative investment classes, while imperfect, show that only private equity has outperformed the S&P 500 over the past ten years.

Of course, there are some high-net-worth investors whose investments in private credit, real estate, or hedge funds beat the market.

It's no surprise that the average portfolio of high-net-worth investors is tilted toward listed equities and private equity, the two top-performing assets.

Alternative investment assets under management are projected to reach $17.2 trillion in 2025, over four times the 2010 level

Total alternative assets under management are projected to reach $17.2 trillion by 2025, according to Preqin, a firm that provides data and analytics on alternative investments. That's about a 320% increase from the $4.1 trillion in alternative assets under management in 2010.

Despite a slight decline in alternative assets under management from 2019 to 2020, annual growth from 2021 to 2025 is projected to exceed all previous years other than 2018.

81% of institutional investors intend to increase the allocation of their funds in alternative investments by 2025

In line with alternative assets under management expected to grow, 81% of institutional investors surveyed by Preqin intend to increase the allocation of their funds to alternative investments by 2025.

Just 3% intend to decrease their allocation to alternative investments in that timeframe.

79% of institutional investors will increase allocations to private equity

79% of institutional investors will increase allocations to private equity by 2025, per Preqin -- no surprise given strong returns in recent years.

Two-thirds of institutional investors say they'll boost funds invested in private debt and infrastructure, while just over half say they'll do the same for real estate.

The value of rare whisky, classic cars, wine, and handbags are up over 100% over the past 10 years

Luxury goods and other collectibles, despite their flashiness, don't make up notable slices of the alternative assets portfolios of the wealthy. However, the value of luxury goods has grown by 129% over the past 10 years, as measured by the Knight Frank Luxury Investment Index.

Rare whisky has seen explosive growth in value over that period with a 478% increase. Handbags, wine, and classic cars have also notched increases in value of over 100% over the past ten years.

COVID-19 has thrown a wrench in luxury goods investing. Values of art, rare whisky, diamonds, jewelry, and coins dropped in 2020 as supply chain issues crunched production and delivery and normal methods of sales like auctions and other face-to-face interactions were snarled by the pandemic.

Clearly, some luxury goods have grown significantly in value and can offer many of the same benefits of other alternative investments. So why do they hardly register in the alternative investment portfolios of the wealthy?

There are a few reasons:

  • Luxury goods are illiquid. They can be expensive and time-consuming to buy and sell even in small quantities.
  • They're risky and relatively unregulated -- counterfeit art, for example, is a long-standing problem and sales are not always reported.
  • Historical data for particular items can be lacking.
  • Some luxury goods can require significant costs over time for things like maintenance and upkeep.

Pros and cons of alternative investments

Alternative assets are attractive because they offer diversification, have less correlation to the stock market than traditional investments, and can be a hedge against inflation.

Some invest in alternatives with the hope that they'll outperform the market, though data compiled above suggests that, on average, most alternative assets don't generate better returns than the S&P 500.

Alternative investments also come with some unique challenges. They can be risky and lack the regulation and transparency investors are used to when buying and selling listed equities. Certain alternative investments can be relatively illiquid, hard to buy or sell, and expensive to maintain.

And actually making these alternative investments can be more complicated than simply buying equities on an exchange.

From alternative to mainstream

With ultra-high-net-worth investors devoting 50% of their investment portfolios to alternative assets and 81% of institutional investors planning to move more assets into alternative investments, it's clear that alternative investments are actually mainstream for the wealthy.

What about retail investors who generally don't have access to major types of alternative investments?

The picture is mixed, but there's some reason for optimism. 50% of fund managers surveyed by Preqin reported that they don't offer alternative investments to retail investors and have no plans to do so. On the other hand, 17% of fund managers responded that they don't currently offer alternative investments to retail investors but plan to do so in the future, and 15% said they do offer access to alternative investments and plan to expand their offerings.

When it comes to luxury goods and collectibles, new funds and platforms are popping up to give the average investor the ability to invest in shares of fine wine, art, cars, and so on.

Real estate investment trusts have become a popular way for everyday investors to tap into the real estate market.

And retail investors already have cryptocurrency -- a relatively new alternative investment -- on their radar.

For the ultra-wealthy, however, alternative investments aren't going anywhere.

Outside experts weigh in

Andy Puckett, PhD, Professor of Finance at Haslam College of Business, University of Tennessee

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.

Richard Warr, Professor of Finance at Poole College of Management, NC State University

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!

Dr. Pamela Drake, Professor of Finance at James Madison University

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?

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