Alternative Investments on the Rise: Discover the Leading Sectors for 2023

With the volatility that has dominated traditional asset markets for the past two years expected to continue in 2023, institutional investors are increasingly looking to alternative assets to provide yield and stability to their portfolios.

Two-thirds of institutional investors surveyed by Natixis said that they expected a portfolio that included a 20% allocation to alternatives would outperform a more traditional 60/40 investment mix. A growing number of defined contribution managers are looking toward following that lead and incorporating more alternatives into their plans as well.

Democratization of Alternatives

The increased interest reflects an ongoing trend toward the “democratization of alternatives,” Brown says, as the industry looks for ways to open up access to investors that may previously have not had access to them.

Another factor that has encouraged plan sponsors to expand their allocation to alternatives is the Department of Labor letter that came out in December 2021, with guidance around incorporating private equity into DC plans, including keeping such investments in a multi-asset framework run by someone who understand private assets.

“Plan sponsors are looking at how they can offer additional flexibility within plans and something that’s not correlated with the markets,” Vandermillen says.

Still, the inclusion of private assets within workplace retirement plans remains relatively low. Within target-date funds, just 9% of plans hold real estate private equity and 5% hold real estate private debt, according to PGIM, and numbers are even lower for those holding hedge funds, private equity, or liquid alternatives.

Private real estate assets are a common starting place for plan sponsors working on an alternative strategy.

“A lot of conversations center around the ability to invest in real estate and how the plan is providing access to real estate as an asset class,” Vandermillen says. “There are a lot of different flavors and a lot of different ways to do that.”

Beyond real estate, some plan sponsors are starting to look at other asset classes, including private equity, private real estate, and infrastructure, says Michelle Rappa, a managing director and client advisor with Neuberger Berman.

The Top 5 Alternative Investment Sectors

When deciding what to invest in, or whether your industry will be affected, these are some of the top trends in alternative investment I’ve witnessed gain steam:

1. Merchant Debt/Factoring

These are types of business loans. Specifically, they are loans providing funds to established companies that have a track record of cash flow and financial performance. As an investment, which is typically done through a fund or lender, it is effectively buying or loaning against future cash flows into a business.

The borrowing entity gets money to use as working capital or to expand faster up front. They give up a percentage or regular repayment to lenders as the money flows into their company.

A pro for investors is that these can include attractive yields, which may be directly or indirectly linked to underlying business assets.

Of course, no business is guaranteed to survive. So, to avert the cons of borrowers failing to make good, it is important for investors to invest through an intermediary with low default rates and with a broad enough portfolio so that the performers outweigh any defaulters or delinquent payments.

2. Private Equity Healthcare Investments

From telemedicine to biotechnology, to cannabis, this space is exploding, especially in the wake of Covid. It is perhaps one of the best areas of growth for those seeking more upside in their portfolios.

There are a variety of ways to get involved in this asset class, from angel investing to investing through pre-IPO funds or VC and private equity firms.

The most obvious con is that not every one of these companies will make it in the end. The process of bringing new technology to market, and through all of the regulatory hurdles in this space, can be lengthy. Investors can offset this with a portfolio of these companies, investing in a variety, including ones with more growth potential and less risk.

This is an investment that can be incredibly impactful on the world and give investors a feeling of making a difference while also generating attractive returns.

3. Artificial Intelligence

AI investments continue to be trending. This can apply to investing in next-generation, AI-powered funds that analyze the market and invest for you. Automated, AI-backed investing can help take the headaches and time drain out of investing and more accurately invest based on more data points than any human team could possibly evaluate.

There is huge potential for growth in AI startups that are successful. This is why many of the largest VC funds and notable angel investors have been going big into this sector. Of course, if you don’t understand these technologies, it may be hard to judge which will make it or not.

4. Real Estate

Real estate has long been one of the most popular alternative investments. While it may not make the top three this year due to interest rate trends and a cooling of peak home prices, this is still an asset class that can provide concrete downside protection and passive income.

In fact, I believe flight capital from traditional investments and crypto may help provide real estate with an extended run.

5. Ancillary Trends

There are also creative and niche ways to invest around these trends or combine them as well.

For example, you could invest in medical real estate like lab space and medical offices. You could look into Bitcoin ATMs instead of crypto. Ancillary investments could be raw materials and infrastructure used in other popular asset classes.