Exploring Alternative Investments: Unveiling the allure and risks.

Within the INVEST quadrant, the term ‘shiny things’ is a recurring motif, serving as a placeholder for a diverse array of investment opportunities. Due to space constraints in the book, delving into the nuances of these “shiny” investments was a challenge.

However, unbound by word limits here, I am freer to delve deeper into these tantalising prospects, dissecting their characteristics and elucidating why they may not be, on the whole, the wisest choices for the levelheaded investor.

Let’s begin by deciphering the essence of what constitutes a shiny thing. Often categorised as alternative investments, these assets diverge from the traditional realms of equities, fixed income, and property.

They occupy a spectrum, ranging from the realm of acceptable investments endorsed by seasoned investors and institutions, to the perilous territory where allure may obscure reality. It’s crucial to discern that not all non-traditional investments are inherently flawed. However, their suitability for the majority of investors, and their alignment with investment objectives warrants scrutiny.

Navigating this spectrum is subjective and lacks a precise scientific framework. Yet, it’s imperative to resist the temptation of assuming that proximity to the extreme end of the spectrum equates to merit for inclusion in one’s portfolio. Professional investors may entertain certain candidates, such as precious metals like gold, complex financial instruments like swaps and futures, and structured products. Conversely, at the opposite pole lie assets like art funds, whiskey casks and cryptocurrencies, while intermediaries like forestry and private equity find themselves amidst the continuum.

Understanding the raison d’être of alternative investments warrants examining why they exist alongside the classic investment buckets. In times of market volatility or when conventional assets fail to deliver desired returns, investors often seek refuge in the promise of uncorrelated, high-yield alternatives. However, chasing the elusive promise of exorbitant returns devoid of risk is akin to chasing mythical creatures—ultimately futile.

This introduction serves as a prelude to a more in-depth exploration of alternative investments, recognising that some shine brighter than others. And some as are downright dull! I will dissect each contender, evaluating their composition, existing investor interest, and rationale behind their suitability—or lack thereof—for inclusion in an evidence based Levelheaded portfolio.

This divergence from traditional investment paradigms isn’t exclusive to private investors; institutional investors, fund managers and even large endowment funds also seek to augment returns, sometimes venturing into uncharted territory. However, do not be fooled into thinking these so-called professionals are any more likely to find a mythical creature than you are.

The inherent risks underscore the importance of a discerning approach, with a gentle reminder from Shakespeare’s The Merchant of Venice, “All that glisters is not gold”. On that note, let’s kick off the discussion with gold – both physically and metaphorically a shiny thing…unless of course it’s iron pyrites – fool’s gold!

Throughout history, gold has captivated human fascination. Its enduring lustre, preserved by its resistance to oxidation, renders it visually and tactilely appealing. However, gold remains inherently inert, devoid of any income-generating capabilities, and its value is solely contingent upon the subjective demand it commands in the marketplace. Consequently, traditional valuation frameworks,  relying on cash flow analysis are rendered ineffective when applied to gold.

I have quoted Warren Buffett on numerous occasions, and this seems a good time to wheel out the Oracle of Omaha once more:

‘This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe that the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it more avidly in the future…Gold, however, has two significant shortcomings, being neither of much use or procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for eternity, you will still only own one ounce at its end.’
(Warren Buffett, 2012)

Some interesting facts about gold:

Positives about investing in gold

Negatives about investing in gold

The uninformed investor often sees gold as a quick bolt hole during times of equity volatility. The facts are that gold is c. 24% more volatile compared to a 50:50 blend of US and international equities. US and international equity standard deviation** averages 16%, whereas gold was a notch over 20%. This difference may not seem particularly large, but it shows that gold is not the smooth, safe panacea some investors believe to be the case. The gold price volatility does smooth out over time with a reversion to mean, as do equites, but in the act of hunting a haven this is akin to jumping from the pan into the fire but with the added of conundrum of when to get back into the pan!

Standard deviation of monthly returns | The Level Headed Investor

Read more here on the Morning Star website

During 52-years (Sept 1971- Aug 2023) in the worst 10 and 20 year timeframes gold did not deliver on what matters – the preservation of buying power, when compared to equities and US Treasuries. Over a decade, which was tough for all four asset classes, gold almost halved in buying power, whereas a 60% equity (50% US:50% International)/40% US treasuries would have only lost c. 4%. It is worse for gold over the worst 20 years. It shrunk its buying power by a whopping 59%, whereas the 60/40 portfolio rose by 87%.

Gold is often perceived as a hedge against hyperinflation, which is the rapid and uncontrollable increase in the general price level of goods and services. However, there are several reasons why this may not be the case. When there is a need to generate quick income in order just to buy a loaf of bread, gold’s poor liquidity becomes a barrier and not a boon.

When hyperinflation kicks in, there is also the very real risk of Government confiscation, as happened in the US in 1933. Unlike other tangible utilities, gold has limited intrinsic utility value unlike property or agricultural commodities. Therefore, its significance to what is really important, food and shelter, becomes almost meaningless, and as such losses its purchasing power very quickly.

Lastly, and slightly tongue in cheek, owning gold is one thing, but how and where to store it due to its bulk and weight needs practical consideration. Wandering around with a gold bar in your bag comes with all sorts of dilemmas irrespective of any perceived ‘Armageddon’ scenario. Holding gold as an investment can be done in numerous other ways, including Exchange-Traded Funds (ETFs), mutual funds, futures contracts, options, mining stock, gold royalty and streaming companies, savings accounts and finally, gold certificates. Just a few options to add to the dilemma!

At the time of writing (May 2024) gold prices are at an all-time high, caused by political unrest and angst in several geographical arenas and trading disagreements between major economic powers, amongst other things. Remember, there will always be a reason to be nervous about markets and there is always unease somewhere in the world if you look hard enough.

Whatever you hear, whatever you feel, calm your fearful inner voices. The answer to an emotional investment wobble is not a knee jerk reaction to buy gold. Instead, forge ahead with a well-diversified levelheaded portfolio and see gold for what it is – just a ‘shiny thing’.

*Fiat currency is declared legal tender by the government that issues it. This includes money in circulation such as paper money or coins. Fiat money is backed by a country’s government rather than by a physical commodity such as gold.

**Standard deviation – shows you how much a fund’s returns vary from the average.


Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale.

This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.