Alternative investment trends 2020/2021

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We focus on senior secured direct lending strategies with short durations that offer stable and attractive returns, protection and liquidity.

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This article was written in collaboration with Maxence Louvrier. 

Financial assets which do not fall into the conventional categories of equities, fixed income or cash have been an ever-increasing part of investors portfolios. Alternative investments can be divided into two broad but practical categories; private assets and hedge funds. The focus varies depending on the state of the economy and how investors are willing to allocate resources. A general investment switch which has rallied vast crowds in the past decade is the ever growing importance of private debt. However, four other alternative investments trends have received a lot of interest over 2020 and early 2021, but all come with different risk/reward profiles.

Cryptocurrencies, or commonly called cryptos, are digital currencies and have been on the hype since last year, attracting many new and small investors. Just like Fiat currencies, they fulfil the three main functions of money. First, they are a medium of exchange as economic agents use them to purchase and sell goods and services. Second, they are an agreed measure for stating prices, thus being a standard of value, even though this can differ from crypto to crypto. The third function is also variable depending on the crypto, but they can be used to transfer purchasing power from present to future, acting as a store of value, from which can be derived interest rates. The difference from other currencies is that these coins are independent of any governmental or central bank influence. Furthermore, they are highly fungible and most of the transactions can be made anonymously. This has attracted less than reputable individuals and firms to pay for their nefarious activities without worrying about regulators or law enforcement. The leading cryptos that most investors have heard about are Bitcoin, Ethereum, Ripple and Cardano, although there are thousands of them. However, cryptos have been observed to be volatile, extremely volatile; and it would not be considered bizarre to observe a daily variation of 5% or higher. The trends for 2021 are that the fluctuations are likely to continue to be observed. On a more extreme example, Bitcoin has had its annualized 30- day volatility reached 116.62% on May 24.

Non-Fungible Tokens (NFTs) are a very recent investment vehicle. These tokens are used to represent the ownership of a specific item, whether it be tangible or not. One can think of it as a digital act of property, where it is unique, and its validity can be publicly accessed to verify its authenticity. This is because NFTs are stored on blockchains, hardly hackable databases, and are therefore very secure. Furthermore, despite public access to the data, NFTs cannot be modified or copied, making for the optimal proof of ownership. This asset has enjoyed extreme momentum and an estimated USD 2 bn has been invested in NFTs in 2021 Q1. The usual NFT investment is made in art or collectables, but it has been used in games, royalties, and patents. Such assets have usually been compared to art, for there are some extremely valuable pieces but also a significant quantity of worthless ones. This makes for an increase in the risk as it is challenging to value NFTs correctly, and thereby properly assess the investment’s risk and reward.

In the past, the investment trends for economic agents were to place their capital in traditional real estate investment trusts (REITs); however, many are now turning to directly own real estate without the help of professional advisors. An essential advantage of real estate is its versatility; one can purchase land, residential, commercial, or industrial properties. The yield comes from the rent and the appreciation of the property. These yields are often independent of the usual investment, whereby an onerous piece of apartments may not grow as rapidly as less expensive acquisitions. The main factor influencing growth here is the location. Popular locations will drive up demand and thereby the value of the property independently of its initial value. Investors usually have the opportunity to leverage their initial investment without significant problems, as commercial banks are inclined to finance such investments given the security of having valuable collateral. The downside of such an asset class is its illiquidity, for the likelihood of one selling or exchanging one’s property for cash in a rapid manner without incurring substantial loss in value is meager, but also the complexity in assessing proper due diligence. Furthermore, regulations surrounding real estate varies greatly from country to country, even in close ones like France and the United Kingdom. In mainland France, the legal cushions in case ill-intended tenants do not pay rent are very weak. Indeed, the procedures are usually very lengthy, and the chances of getting reimbursements are low as the French system greatly favors tenants.

Lately, a lot of attention has been paid to peer-to-peer lending, where individuals or institutions lend to other individuals or institutions via the intermediary of a specialized company, a fairly new alternative investment trends. The money coming from the lenders is put inside an indiscriminate pool and is then allocated to a borrower. Loans can be offered for any purposes: businesses, personal use, etc. Several platforms are available to investors. Borrowers use these platforms as alternatives to traditional loan providers like banks; usually leading to an increase in the risk, from which are derived higher interest rates. The interests are typically delivered on a monthly basis and are variable on the specific terms of the credit lent. These platforms are available to institutional investors as well as individuals, and for the latter, the initial investment can be as little as one pound. Very rarely have institutional investors and individuals been observed financing the same projects, with obviously very different contributions. Apart from the high interest rates, the advantage for lenders is the possibility to tailor credits according to their will or needs. With the help of specialized platforms, they will contribute a certain percentage of the desired project and receive interest rates accordingly instead of placing money in a fund, for example. However, many of these projects have been known to fail due to a lack in assessing proper due diligence on both projects and collaterals linked to the project.

In constant search for higher returns and stronger protections, many investors prefer to trust and allocate their money to private debt funds, which have proven to be the best alternative to traditional asset classes. Thanks to their non-bureaucratic models and quick ability to deploy cash, private debt fund managers are able to secure high interest rates from small and mid-sized companies that are left without source of funding, always offering higher collaterals to secure funding. Furthermore, the standard at which these funds are usually held provides for excellent security, as due diligence plays an extremely important role in these structures. The purpose of having professionals carrying the research and analysis processes is the certainty for optimally allocated investment with regards to the risks, thereby strengthening alternative investment trends. Focusing on Senior-Secured Direct Lending strategies of short duration such as Factoring, Bridge Lending and other credit opportunities, private debt fund managers target annual return ranging from 8 to 10%, while mitigating the illiquidity risk with investors pocketing the illiquidity premium without sacrificing liquidity. These risks are driven from different debt assets: the lower interests are usually linked to senior debt. This is because, in case of bankruptcy, senior debt this the first one to be reimbursed with the companies’ assets, real estate collaterals for example. This greatly differs from other debt strategies like mezzanine, subordinate or distressed private debt, bringing in high returns, but also an increased risk due to their low seniority in the borrowers’ balance sheet. As a rule of thumb, there are always several investment trends for capital allocation which are attracting economic agents. However, these trends for 2021 can be rapidly synthesized into ones which are likely to offer high return, private debt, and others, riskier and more uncertain like cryptos.