The Evolving World of Alternative Investments for Self-Directed Retail Investors
Not long ago, I got interested in the subject of financial bubbles and decided to improve my understanding of these periodically occurring phenomena. While reading John Kenneth Galbraith’s Short History of Financial Euphoria, it struck me that his main premise was that
...financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation of an established design…” Yet, financial bubbles keep occurring due to “...the brevity of the financial memory.
I’m not convinced it would be wise to challenge the premise of a celebrated economist like Galbraith. Yet I couldn’t help but notice that in the past few years, a lot of new asset classes have become accessible to self-directed retail investors. My own humble investment pursuits have led me to consider getting involved with crowdfunding investments, renewable energy investment trusts, and listed options. But the list doesn’t stop here (bitcoin, anyone?).
Are These Assets Novel in Any Way?
Let’s take a look at a few examples of alternative assets to try to figure out if they’re at all novel.
Crowdfunding offers a means to raise finances for a given project or venture by collecting small contributions or investments via an online platform. The first example of this approach was a rewards-based campaign for producing music and other art forms in the US starting in 2003. A couple of years later, debt and equity crowdfunding platforms appeared both in the US and the UK, touching off an explosive growth in the industry. By 2015, more than USD 34 billion had been raised through such platforms globally. In essence, these crowdfunding platforms provide an alternative way for startups and small and medium-sized enterprises (SMEs) to get access to equity or debt finance, and in this respect, they resemble angel investors, venture capital funds, and various SME lenders.
Renewable Energy Investment Trusts
Renewable energy investment trusts provide investors with a chance to get exposure to a portfolio of renewable energy-generating facilities (e.g., wind farms or solar photovoltaic plants). The first examples of trusts investing in renewable energy assets were launched in the UK in 2013 (e.g., BSIF, FSFL, NESF, and UKW—their ticker symbols on the London Stock Exchange). However, investment trusts have been around for more than 150 years, wind turbines for almost 120 years and solar photovoltaic cells for about 70 years. In substance, these investment trusts offer exposure to a form of infrastructure investments with the typical (for this asset class) long-term project life and stable cash flows.
Listed options provide an alternative way for investors to get exposure to all sorts of exchange-traded underlying assets, from individual equities through equity indices and commodities to, more recently, exchange traded funds (ETFs). Options as an asset class are not new, with the first listed options launched in 1973 on the Chicago Board Options Exchange (CBOE). But they have only recently become widely available to retail investors with the proliferation of low-cost online brokers. What’s different (or alternative) about listed options is that the availability of liquid put and call options with different strike prices and expiration dates allows an investor to tailor his or her payoff in many ways that wouldn’t be possible when buying or selling short the underlying asset.
Bitcoin is the first decentralized digital currency based on the revolutionary blockchain technology. The foundation for the emergence of bitcoin was laid in 2008, and I can hear you saying, “Gotcha, this is something really new!”
Well, the technology underlying bitcoin is indeed novel and has significant potential to revolutionize the way people do certain things. However, what isn’t so new is the fact that under the hood, bitcoin is still only a currency that can be used to buy goods and services or exchanged for other (traditional) currencies, even though this isn’t how the current buyers of bitcoins seem to look at it.
By now, it should be clear that these assets might not be all that novel or alternative in terms of their nature and the type of exposure they provide (I knew it wouldn’t be a good idea to challenge Galbraith on that point, but don’t take my word for it). What might be less obvious are the factors that made such assets enter the investable universe of self-directed retail investors.
There are two main forces acting together to make these assets accessible to retail investors. On one hand, the underlying markets have matured enough to provide a sufficient pool of assets for investing beyond the realm of professional/institutional investors. For instance, in 2016, the newly built generation capacity of renewable energy sources reached 154 GW globally. So it should come as no surprise that the four investment trusts mentioned above (BSIF, FSFL, NESF, and UKW) have reached a combined market cap comfortably exceeding GBP 2 billion (as of April 2017)—a major growth in value in less than five years. Similarly, the total amount of crowdfunding grew from USD 2.7 billion in 2012 to USD 34.4 billion across hundreds of different platforms globally.
On the other hand, technological developments in the form of the internet, social networks, and blockchain technology have allowed such assets to be packaged and distributed to retail investors in quick, cost-efficient, and safe ways. For example, one can evaluate a potential investment in a startup by reviewing the company's presentation and due diligence findings online on the crowdfunding platform’s website. Plus, the cost of building a diversified portfolio of such investments is minimal, as many platforms offer automated diversification tools. You can even trade listed options for less than USD 1 per lot, thanks to efficient online technology and the proliferation of competing exchanges.
So it’s clear that the investable universe will keep expanding, giving self-directed retail investors more opportunities to tailor their portfolios and achieve their desired risk/reward balance and return profile.
Should You Consider Investing in Alternative Assets?
I’m certainly not in a position to offer recommendations on specific investments, but from my experience, it’s worth exploring the wealth of new investment opportunities and trying to understand how they can complement and enhance your unique investment strategy.
My experience to date has been positive and quite educational. In a series of posts, I’ll aim to share what I’ve learned and delve deeper into the features of these assets while offering some useful insights.
And one last thing: since I started the post with the financial bubbles, I’d like to end it on the same note. Do you happen to know which currency has appreciated about 240 times against the USD in the last five years?
… bitcoin, anyone?
About the Author
Nikolay Angelov, CFA, works at a development bank, where he specializes in structuring and financing renewable energy projects, as well as developing and implementing financing products for small and medium enterprises. He is also an avid self-directed options trader. In his free time, he likes to go cycling and race go-karts.