An alternative outlook in the plague year

Before we examine whether retail investors stand to benefit from increased access to alternative assets, it is worth highlighting the impact that the extraordinary events of 2020 have had on conventional share trading volumes. A combination of Covid-19 lockdowns, government stimulus measures and the shortest bear market in history has been driving market participation – with retail investors having an outsized influence on valuations. 

Retail participation – a central feature of 2020

Analysis published midway through the year by Larry Tabb, head of market structure analysis at Bloomberg Intelligence, showed individual stock trading at a 10-year high, with US retail trades estimated at 19.5 per cent of all US order flows, around double the rate from 2010. Figures from ShareSoc suggest that level of participation was mirrored on this side of the Atlantic, with retail stockbrokers reporting record trading volumes, in turn underpinning the relief rally during the second quarter of 2020.

Aside from the unlikely confluence of events this year, there have been some practical reasons why more retail investors have entered the fray: improved accessibility, lower dealing commissions and the roll-out of user-friendly trading apps have all played a part. The rise of the day trader is also a factor, evidenced by increased volatility among thinly traded small-cap stocks. We may also be witnessing increased appetite for risk with the US presidential election now out of the way. 

That individual investors appear to be entering or re-entering the market in significant numbers is encouraging, but we will need to wait until the vaccination programme starts to arrest the spread of the virus before we make any judgement on long-term investment trends, particularly as concerns over the terms of our exit from the European Union still predominate – UK equities are hardly flavour of the month despite strengthening volumes.

An alternative universe on offer

Away from the vagaries of equities, there are other channels of wealth to consider. Our Christmas issues usually contain an article devoted to alternative assets classes; those that do not fall within the narrow confines of publicly traded stocks, bonds or certificates. 

We tend not to include any reviews of the buy-to-let market, as this receives regular attention throughout the year. So, we are usually left with things like en primeur wine, vintage automobiles, or the stuff that Stanley Gibbons (SGI) is made of – ground zero for hobbyists, collectors and philatelists alike.

As a rule of thumb, alternative investments tend to be somewhat illiquid, but certain asset classes have become more accessible through exchange-traded and mutual funds, thereby enhancing the ability to get in and out of trades. You can also dabble in managed futures, in addition to derivatives contracts, certain private equity plays or venture capital – but they remain largely the preserve of institutional investors, certainly when judged in dollar terms.

Private markets – the final frontier?

Retail investors still find it virtually impossible to gain exposure to certain alternative strategies. However, regulators are now looking at ways of expanding opportunities – and it is not difficult to appreciate why. Consider that private equity’s aggregate net asset value has recorded explosive growth over the past two decades, increasing twice as fast as global public equities, while propping up M&A markets both in the UK and abroad, yet the retail market remains underserved in this area. 

The McKinsey Global Private Markets Review states that the number of private equity-backed companies in the US more than doubled in the period 2006-17, a dynamic also in evidence on the London Stock Exchange and the wider economy. The consultants conclude that “private markets have graduated from the fringes of the economy to the mainstream”, perhaps raising the question as to whether they classify as alternatives in the strictest sense. For retail investors, the main consideration is how they can capture a bigger slice of the growth in this corner of the market.

Matthew Hudson, chief executive and founder of asset management consultancy MJ Hudson, told the Investors Chronicle that “the growth of private debt markets” is perhaps the standout feature in the development of tailored alternatives over the past decade, although he foresees accelerated growth in both infrastructure and the renewables space on the back of the US election result – a potentially positive beat for retail investors given the prospect of improved accessibility.

Private fundraising may have slumped in the first quarter of this year, but sentiment remains favourable. An institutional survey conducted by IFI Global indicates that the overwhelming majority of investors and asset managers still believe the market will continue to grow in the coming years, a partial reflection of the changes in credit markets in the wake of the global financial crisis. 

Private channels are increasingly to the fore in areas of the economy where bank support has waned due to beefed-up capital adequacy requirements. The McKinsey review notes that assets under management have grown steadily each year and had reached a record $812bn midway through last year. 

For now, access for retail investors to private companies is limited, meaning that they are under-allocated in alternative asset classes, at least in the financial sphere. And because we are seeing a gradual decline in the number of publicly listed companies, the ability to achieve meaningful diversification without an allocation to private markets will become even more difficult as time moves on. 

Private access and the question of liquidity

Without greater access, retail investors may also struggle to capture uncorrelated returns. It can be shown that private equity has registered higher returns and lower volatility than public markets over the past two decades. So, it is unsurprising that national regulators, most notably the US Securities and Exchange Commission (SEC), are intent on expanding retail access to private markets.

Things may be moving in the right direction for European investors. French public investment bank BPI has just launched a fund to enable retail investors to access private equity strategies as part of a government programme designed to encourage greater participation in long-term investments. Across the pond, the SEC may ease liquidity constraints for target date funds with longer investment horizons, thereby providing greater flexibility to invest in illiquid assets. 

Some of our readers, at least those who were caught up in the Woodford Equity Income fund, may baulk at the suggestion, although Andrew Bailey, in his previous incarnation as chief executive of the Financial Conduct Authority, stated publicly that the UK still needs investment in illiquid assets despite the Woodford scandal.

Cryptocurrencies – a symptom of a wider malaise

Speaking of liquidity issues. Mr Bailey, in his new role as Bank of England governor, recently gave his verdict on Bitcoin, a medium of exchange (and alternative asset class) he believes is “fundamentally unsuited to the world of payments where a certainty of value matters”.

In the run-up to this festive season, you may have become aware of the increased clamour surrounding cryptocurrencies. A quick check on Google shows that search engine results for the term ‘Bitcoin price’ are demonstrating their highest frequencies since midway through last year, although they fall short of their high-water mark recorded in December 2017, the last time the price spiked. Nevertheless, there has been a deluge of articles detailing why “two-thirds of millennials prefer Bitcoin to gold as safe-haven”, or even “Bitcoin: this time it really is different”.

But why is it different? And different from what exactly? Different from the 84 per cent paper loss incurred by punters in the 12 months after they bought in at the tail-end of 2017, when the flagship cryptocurrency was trading at $18,950 a coin? Indeed, around $400bn was wiped off the value of major cryptocurrencies in the first six months of 2018. But the curious thing is that the answers as to how this could have happened are every bit as nebulous as the justification provided for the price surge now under way.

Tub-thumpers for Bitcoin – and there are plenty out there – will point to a weakening US dollar and growing fears over an inflationary spiral, while others will cite increased demand from institutional interests. But why we should confer legitimacy on a highly erratic store of value simply because a few financial firms give their support is anyone’s guess. After all, synthetic credit default swaps must have seemed like a good idea to some people going into 2007.

The trade in Bitcoin, which has been playfully cast as the “digital version of the Semper Augustus tulip”, shares several characteristics routinely attributed to market bubbles, not least its reliance on ‘churn’ in the absence of an objective valuation anchor. It is also worth remembering that bubbles have a propensity to develop during periods of low interest rates.

You need to ask yourself what impact the introduction of central bank digital currencies would have on independent cryptocurrencies before you determine whether they constitute a viable alternative asset class. You may be better advised to see how you can tap into the expected growth of the blockchain technology that underpins them. And even if you are concerned over the issue of currency debasement, you can simply pick up the phone and call a reputable bullion dealer.