Democratizing alternative investments: Unlocking opportunities for retail investors

Insights

• Alternative investments are nearly a $13 trillion market. Retail investors are increasingly drawn to these alternatives due to their potential for higher returns and to reap the benefits of diversification.
• Key issues include valuation difficulties, liquidity constraints, and the need for robust regulatory frameworks.
• To successfully navigate the complexities associated with alternative investments, investment managers, retail investors, and intermediaries must:
  1. Invest in technology
  2. Prioritize data analytics
  3. Enhance investor education
  4. Establish clear regulatory frameworks
  5. Strategic portfolio allocation
  6. Anticipate long-term commitments

The shift to alternatives

Retail investors now represent the fastest-growing segment in alternative investments — a market valued at nearly $13 trillion. Historically exclusive to institutions and ultra-wealthy individuals, asset classes such as private equity, private credit, hedge funds, real estate, commodities, and digital assets now offer retail investors higher returns and improved portfolio diversification. Recent research indicates that 90% of financial advisors already integrate alternative investments into client portfolios, with half allocating more than 10% of client assets to alternatives, expecting this share to increase significantly in the next two years. This trend underscores a significant paradigm shift, influenced by prolonged low interest rates and inflation concerns, making alternatives attractive options for enhanced returns.

Figure 1: Alternate investments have been steadily growing

Source: Bain, Preqin, GlobalData

Understanding alternative investments

Alternative investments, including private credit, private equity, hedge funds, real estate, commodities, and digital assets, attract retail investors due to higher return potentials and diversification benefits. These asset classes often have lower correlations with traditional market movements, providing valuable risk mitigation during economic downturns. The recent underperformance of traditional assets has accelerated retail investors’ shift toward alternatives, mirroring investment strategies of ultra-high-net-worth individuals who typically allocate up to 30% of their portfolios to alternatives.

Key challenges to retail adoption

Retail adoption of alternate assets presents a unique set of challenges that can significantly impact investor decisions and outcomes. These challenges include:

• Valuation difficulties: Private assets often lack standardized valuation metrics, complicating investor decisions due to unclear pricing structures, especially in private equity markets. Unlike publicly traded assets with clear market values, alternative assets require specialized appraisal methods, making investor due diligence challenging.
• Liquidity constraints: Alternatives often have limited liquidity compared to public markets. Most private firms are not publicly listed, making it difficult for investors to liquidate holdings quickly. Investors thus need careful financial planning to accommodate long-term investment horizons.
• Investor education gap: Many retail investors and advisors lack sufficient knowledge about the complexity and risks of alternative investments, hindering informed decisions. Retail clients require tailored educational materials and interactive tools that clearly explain potential returns and associated risks.
• Inconsistent regulatory frameworks: Regulatory approaches vary significantly globally, especially in emerging areas like cryptocurrencies, creating uncertainty and caution among retail investors. Without consistent and transparent regulations, investors face increased exposure to risks of fraud or asset mismanagement.

Harnessing technology: The key enabler in retail alternative investments

Technology significantly increases the accessibility of alternative investments. Digital investment platforms, fractional investing apps, and AI-powered analytics democratize participation and provide critical investment insights. These innovations enable investors to enter previously inaccessible markets with smaller investment amounts, significantly lowering barriers to entry. Initiatives like BlackRock’s acquisition of Preqin highlight industry efforts to standardize private market valuations, improving clarity and confidence for retail investors.

Recommendations for effective democratization

To effectively democratize alternative assets and make them more accessible to retail investors, several key recommendations can be implemented:

• Investment in technology infrastructure: Investment managers should utilize platforms like iCapital or CAIS or develop proprietary applications to streamline investment processes, efficiently reach retail investors, and enhance distribution capabilities. These platforms facilitate seamless investor onboarding, portfolio management, and ongoing client support.
• Prioritize data analytics: Establish centralized data hubs and employ AI-driven analytics to improve transparency and optimize portfolio management. Real-time data analytics enhance investor confidence by providing transparent and timely insights.
• Enhance investor education: Develop customized education programs urgently to bridge knowledge gaps, ensuring investors and advisors fully understand the benefits and risks of alternatives. Webinars, interactive content, and practical resources can significantly elevate retail investor knowledge and confidence.
• Establish clear regulatory frameworks: Develop consistent, transparent regulatory guidelines to provide greater investor protection and encourage broader retail adoption. Clear and standardized guidelines ensure investor trust and reduce uncertainty.
• Strategic portfolio allocation: Adopt cautious strategies, recommending retail investors allocate between 5%-15% of their portfolios to alternative assets, managing risk effectively while benefiting from potential returns. Balanced allocations allow for adequate diversification without overly exposing investors to illiquidity or valuation uncertainties.
• Anticipate long-term commitments: Educate investors about typical holding periods of two to five years for alternatives, setting realistic expectations around liquidity and returns. Clear communication on timelines helps manage investor expectations effectively.

Alternative investments for all: A path forward

Retail investors are increasingly seeking alternative investments to maximize return potential and diversify their risk. Successful democratization relies on targeted education, strategic technology integration, robust regulatory frameworks, and cautious allocation strategies. With these initiatives, retail investors can unlock opportunities to invest confidently in alternative investment markets.