Continuing with our discussion on alternative investments last week, this week we would like to expand on this subject by discussing specific categories of alternative investments along with their pros and cons.
If you remember from last week’s discussion, the following are the major categories of alternative investments:
We’ll evaluate each category of investment based on the various benefits investors seek when turning to various alternatives including:
- Non-Correlation to Broader Markets
- Lack of Volatility
- Cash Flow
- Above-Market Risk-Adjusted Returns
- Security (i.e., backed by hard asset)
This week’s discussion will be focused on the speculation category.
Speculative investments include assets whose profits are derived solely from timing (i.e., buying low and selling high) or from trading strategies involving derivatives centered around timing. Examples of assets falling within this category include cryptocurrency, Forex, and hedge funds.
Here is how these assets stack up:
Non-Correlation to Broader Markets
Cryptocurrency and Forex are generally considered non-correlated to the broader markets. While hedge funds are touted as being non-correlated to the broader markets, research shows otherwise.
Because hedge fund strategies involve derivatives of public equities, they are at their core, connected to Wall Street. Hedge fund managers will argue otherwise, contending that their strategies are designed to profit when the market is up or down. The evidence proves otherwise.
In 2018, a down year for the market that saw the S&P 500 drop 6.2%, hedge funds fell 6.7%.
Lack of Volatility
Since 2012, Bitcoin and Forex have been demonstrated to be extremely volatile compared the stock market while hedge funds have shown less volatility
Speculative investments do not offer consistent income from a regular business operation. Hedge funds distribute any year-end gains but those are neither consistent nor guaranteed.
Neither cryptocurrency, Forex nor hedge funds have provided investors gains from appreciation in intrinsic value over time.
Above-Market Risk-Adjusted Returns
There is no reliable data regarding average risk-adjusted returns of cryptocurrency and Forex because profits and losses are highly individualized (i.e., based on individual traders) with no indices available to show annual gains like with the S&P 500 and the stock market.
Hedge funds on the other hand, on a risk-adjusted basis, underperform the S&P 500. In fact, according to at least one source, the average hedge fund has a hard time keeping pace with Treasury bill returns.
Neither cryptocurrency, Forex nor hedge fund investments are backed by tangible assets. The consequence is that without backing by a tangible asset, it’s possible to lose your entire investment without any recourse.
When it comes to non-correlation to Wall Street, volatility and risk-adjusted returns, the jury is out on the various types of speculative alternative investments discussed in this article.
Whether a particular speculative asset offers these benefits depends on the asset. But when it comes to cash flow, appreciation, and security, it’s clear that speculatives can offer none of these benefits.