Unconventional Alternative Investments

March 14, 2022

Investments can easily get lumped together and labeled similarly. All of the different investments we mentioned in our Traditional Alternative Investments blog can certainly fit in the “traditional” bucket which sometimes doesn’t feel as exciting as other unconventional opportunities. However, that is not to say that they don’t have their place in an investment portfolio. Quite the contrary, in fact. For the right individual or family, investments in these strategies can provide diversification and serve as another way to manage risk in an overall portfolio. That being said, there are some other more unconventional alternative investments that are either newer or a little more abstract that we want to make sure we highlight.

 

Structured Products

There are newer breeds of investment vehicles that have started to become more mainstream. Structured products can be pre-packaged investments that are “linked to an underlying asset with pre-defined features (maturity date, coupon date, capital protection level…).” The mechanics behind the scenes can seem quite complex, but we will outline a few key terms to understand.

  • Term of investment. Be aware of the term. Often, structured products will have terms of 3-5 years. Essentially, you are tying up your investment funds for that term length with virtually no liquidity.
  • Payout profile. The payout profile is what determines how an investor’s returns are calculated. In our case, a point-to-point calculation means that our returns are the growth in the value of our underlying security from the day we invest (point A) to the day our term ends (point B).
  • Participation rate. It’s relatively self-explanatory but essentially, the investor receives whatever their participation rate is of the total return of the underlying security. Oftentimes, structured products will have a “cap” on the amount someone can earn in their investment. But why are there participation rates or caps? The answer is that investment managers often use this as a means to compensate themselves for the risk of managing these products. There will likely be other fees involved, but they have done the math and realize that at a certain cap or participation rate they will return enough to cover their expenses while also providing all the benefits of the product.

 

“Why would we buy a structured product?”

The biggest benefit can be the slight disconnection with day-to-day market swings. We might have a product that is tied to an equity index like the Russell 2000, but by “locking up” our investment we are essentially disconnecting ourselves from the daily fluctuations. By not having super liquid access to our funds, we can’t sell or withdraw when markets fall. This may give one some version of potential downside protection by not allowing panic or impulse selling during market down turns.

Please know, this is a gross oversimplification of structured products. There are dozens of different types that are linked to hundreds of different underlying securities and strategies. By “smoothing” our returns out over a longer period we may offer a level of risk diversification without having to invest in something exotic like a hedge fund or private equity fund.

 

Collectibles

Here is where it starts to get fun. Collectibles as investments have existed for many years, but recently, some exceptional innovations have lowered the barrier to entry for this type of investment. Before we get there, what counts as a collectible? Basically, anything that is of value to someone else. After all, it’s not an investment if we’re not aiming to generate a return on the money, we put in. This can be art, wine, cars, or your kid’s Pokémon cards.

Historically, investing in collectibles has required a significant upfront capital investment. It is entirely possible to get lucky and find something at a thrift store and take it on Antiques Roadshow only to realize it’s worth hundreds of thousands of dollars. More often than not, we don’t know that something has value until the collectible value has already been established. By that point, prices are often out of reach for those just starting their wealth-building journey – however, there are solutions, but more on that later. First, let’s take a minute to understand why we might invest in something like art or wine.

As we mentioned previously – when we invest in alternative methods, we are looking for some version of risk diversification. Maybe we are looking for uncorrelated returns to our stock and bond investments. Or we are looking for something to serve as a “store of value”.  A store of value is something that can be stored and converted to cash at a later date without losing its’ value. It should have a very long lifespan and infinite demand. Gold has long been thought of as an “ultimate” store of wealth, but other assets have come to the forefront as times change.

 

Art*

The art market is massive –  $50.1 billion in sales in 2020 – and possibly trillions of dollars in total assets. Art has long been an investment prized by wealthy individuals because of the scarcity of the goods in question. There’s only one Andy Warhol and he only completed so many works. It’s likely that physically owning an original Warhol will be out of reach for the average investor, but new companies are making investing in his works (and the works of countless other artists) possible.

Masterworks.io has pioneered a platform that essentially turns works of art into stocks. They buy a painting, register it with the SEC, and sell shares of it on their proprietary market. While most of us will never “officially” own a Banksy painting, it’s exciting to be able to participate in the art market at our own level. Rally is another company that sources collectible items, values them, turns them into an individual company, and then sells shares of them on their app/website.

The remarkable thing about platforms like Masterworks and Rally is how they have democratized investing in assets with such a high barrier to entry. Not only do they allow people with smaller investing budgets access to a new asset class, but they also open future investors to a world they might never have gained any experience in. Now, investing in these avenues comes with risks. You are relying on someone else’s valuation of these assets and because they can be traded much more freely, investors are prone to see more volatility in their portfolios. By understanding the risks, though, investors are now able to expand their investing horizons.

*Investments of these types are not facilitated by Avantax.

 

Cryptocurrencies and NFTs

Everybody knows somebody who has gotten into Bitcoin, Dogecoin, or NFTs, but to most of us, it still seems like a foreign language – and understandably so! Hopefully, we can make it a little easier to understand.

It would be easy to say that a cryptocurrency is exactly what it says it is – a digital form of currency – but that is a BIG oversimplification. Youtuber 3Blue1Brown has a super detailed explanation of how bitcoin specifically works. If you really want to “nerd out”, watch this video, but for our purposes, we will use a super basic explanation of what a cryptocurrency or “blockchain” is.

In a few sentences – blockchain technology is a super complex ledger system designed to verify and process transactions between “peers” in any given platform. The transactions get grouped together in “blocks” that have been verified to be accurate. These blocks get chained together, hence the name, to create a trail of “proof” that validates each participant’s balances and future transactions.  Again, there are lots of good informational resources available that go into much further detail than we will here.

The currency part of the system is the “make-believe” money that gets passed between the participants in the network. We say “make-believe” because it’s not “real” money. It can be exchanged for actual currency, but because it lives in a digital world it doesn’t really matter. Think of cryptocurrencies like digital gold or silver. While you can technically buy stuff with gold, almost every store or restaurant wants government-issued currency. Gold and cryptocurrency have value – they are scarce goods that people want to own – but you can’t pay your taxes with them. There are a couple of notable factors about cryptocurrencies and blockchain technology, though.

One is the security and historical record of all transactions. We use “digital” money all the time – we almost never use physical cash anymore – but the traditional digital cash system has its’ flaws. It is reliant on a few key players which means there isn’t much room for competition on cost and ease of transactions. Security in these traditional systems is also lacking. It is relatively easy to perpetrate fraud. In a blockchain network, the amount of computing power it would take to create fraudulent transactions is so incredibly immense that it becomes almost unfeasible (not impossible, just VERY difficult).

Second, there is some scarcity to each currency. Some are much scarcer than others, but the supply of each coin is limited. This gives investment value to these currencies, just like any other commodity. We won’t get into which one is better or recommended, but we will say that for those with the proper risk appetite, investing in cryptocurrency could provide a similar experience to investing in oil or gold.

 

NFTs*

NFTs, or non-fungible tokens, are essentially blockchain-based digital certificates or records that verify the authenticity of a piece of digital work. Typically, we see this as art, but it can be music, games, or almost any other digital asset. We mentioned the scarcity of cryptocurrencies, but this ramps that up even more with NFTs. Just like purchasing non-digital art, there are only so many original versions of an artist’s work. And just like physical art, digital art is prone to have fraudulent copies made. NFTs are different because they have blockchain-based authentication codes that follow it wherever it goes and to whoever owns it. NFTs serve virtually the same purpose as any physical collectible – it’s a store of value. You may see some people make crazy sums of money buying and selling NFTs, but after its newness wears off, we anticipate it serving as a future market for wealth preservation.

*Investments of these types are not facilitated by Avantax.

 

If you have any questions about unconventional alternative investments, let us know. We always love educating and answering questions regarding new and popular investing techniques. Remember, each person’s financial goals are different so these products are not a fit for everyone but can diversify a portfolio in the right scenario.

 

Sources:

https://www.investopedia.com/articles/optioninvestor/07/structured_products.asp

https://www.fidelity.com/fixed-income-bonds/structured-products

https://wealthmanagement.bnpparibas/en/expert-voices/understanding-structured-products.html

https://corporatefinanceinstitute.com/resources/knowledge/valuation/store-of-value/

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