My finances, my projects, my life
November 26, 2022

Alternative investment options for complicated times

Interest rates are rising, inflation is becoming higher and seemingly more persistent, and many stock markets look expensive by historical standards. It may be an opportune moment to start thinking about incorporating alternative options to diversify and, ideally, inflation-proof an investment portfolio, while adding different sources of potential returns.

More than a decade ago, the world’s central banks adopted rock-bottom interest rates and quantitative easing to bring the global economy back from the brink after the global financial crisis. The Covid-19 pandemic prompted them to double down on easy money, while government policymakers sprinkled the fairy dust of public spending into the mix. This trend has contributed significantly to a near-uninterrupted 10-year run of rising equity prices. But there is a very real danger that this benign period for stock markets is drawing to a close. Here are some alternative options for your investment portfolio – although be warned, they may entail different risks from conventional financial assets, and they do not benefit from investor protection rules.

Luxury goods and collectibles

At times when financial markets appear riskier, tangible objects have a certain appeal, particularly fine wine, works of art or jewellery. Equally, they can be a source of pleasure even if they don’t work out as an investment.

However, in some cases they have performed extremely well. The Liv-ex Fine Wine index, the benchmark for high-quality wine prices, is up 13.95% over the past year, although its gain of 16.69% over five years is more prosaic. The art market has also bounced back after a tough year in 2021.

Nevertheless, the performance of many of these assets is idiosyncratic and may be specific to a certain artist, wine vintage or style of jewellery. Valuation can be highly subjective in sectors where assets have no objectively measurable price – they are worth what a buyer is willing to pay. The liquidity of these assets is also a serious consideration. Unless you are particularly experienced in certain markets or can afford to shrug off losses, investment in tangible objects should be undertaken with great caution.

A reputable intermediary, such as an auction house or wine buyer, can help navigate these complex markets, which are full of pitfalls for the unwary.

If you are not an expert, taking advice from someone who is qualified to do so is extremely important. A reputable intermediary, such as an auction house or wine buyer, can help navigate these complex markets, which are full of pitfalls for the unwary.

Precious metals

For many decades, investors have bought gold as a safe haven in which to shelter against catastrophe – rampant inflation, the collapse of financial markets, or economic meltdown. Gold proved a poor investment in the stock market boom years but returned to favour in 2019 and especially in 2020 as investors worried about the impact of the pandemic. More recently the gold price has plateaued as economic recovery has taken hold.

The gold price also has a relationship with interest rates. Because it doesn’t pay an income, its value tends to languish at times when interest rates are rising, as they are today. The emergence of crypto-currencies and their appeal to younger generations of investors may also affect the relative attractiveness of gold. It is possible that bitcoin will start to take its place as an alternative asset for tough economic times, although the volatility of virtual currencies in recent years has made clear they are not a one-way bet.

Other precious metals often follow the trajectory of gold, except where they have a specific and valuable industrial use. Palladium, for example, is used in electronics and chemical applications. It is also worth noting that precious metals can offer effective portfolio protection at times of international crisis.

Commodities have regularly provided a hedge against inflation, since demand rises as the global economy expands, which is liable to pushes prices higher.

Commodities and agriculture

Commodities have regularly provided a hedge against inflation, since demand rises as the global economy expands, which is liable to pushes prices higher. This traditional correlation may be losing some of its force – economic expansion in the 21st century has not necessarily created as much demand for raw materials as it did 20 years ago. The market is also changing as countries start to create green infrastructure and accelerate the energy transition, entailing demand for different types of raw materials.

Commodity prices were strong in 2021 as economic recovery ran into supply bottlenecks, as well as concern over political tension in eastern Europe. The war in Ukraine has since led to a lasting surge in commodity prices.

These factors have contributed to a strong run of performance for commodities and related companies. Investors now have a broad range of options for investment in commodities markets, including cheap and liquid exchange-traded funds or specialised actively-managed funds.

Another diversification option for investors is agriculture. This has attracted wider investment interest in recent years as a sector tapping into growth of the middle class in emerging countries. As living standards improve, people tend to eat more meat, which in turn requires more grain, creating a virtuous circle for agricultural businesses.

There are also threats to global food supply, including climate change and political unrest, that affect food prices. The UN Food and Agriculture Organization estimates that agricultural production will need to increase by 70% by 2050 in order to feed the world’s forecast population of nine billion people. Investing in these assets therefore raises certain moral issues that are not trivial and even more sensitive since the start of the war in Ukraine.

From currencies to catastrophe bonds

Other types of investment reserved in the past for institutions are gradually entering the mainstream, for those with an appetite to take more risk in search of higher returns. Venture capital offers investors the opportunity to benefit from innovative and fast-growing young companies, sometimes encouraged by generous tax breaks.

Private equity investment has seen considerable expansion in recent years, with many large and high-profile companies remaining in private hands for far longer than they would have done just a decade ago.

Increasingly, venture capital and private equity will be the channel to invest in emerging technology companies. This type of ownership gives business owners more freedom than they might have after a stock market listing. Investors interested in venture capital and private equity now also have a range of collective investment options. But investors should also remember that in many cases innovative start-ups never return investors’ money; venture capital firms look to the handful of stand-out successes to compensate for multiple failures.

Currency funds may also provide diversification away from bond and equity markets, because currencies are a relative trade – i.e. one currency against another. Skilled currency managers aim to deliver positive returns in all market conditions, but this goal is very difficult to achieve and many go out of business.

Other options could include catastrophe bonds, whose returns are generally contingent on extreme weather rather than economic disruption. Specialist lending funds have emerged over the past decade as in some countries capital constraints have prompted banks to cut back corporate lending.

Some or all of these investments could play a useful role in achieving greater portfolio stability at a time when the environment for conventional financial markets is less predictable. It is also good investment practice to increase the diversity of your portfolio and look for ways to smooth out returns over time – but always be aware of the potential pitfalls.

Let us end this article by reminding you that the current geopolitical tensions make any medium-term projection particularly delicate and that it is more important than ever to seek the help of competent experts before considering any investment in these alternative options. You have been warned!

It may be an opportune moment to start thinking about incorporating alternative options to diversify and, ideally, inflation-proof an investment portfolio.