As fund manages look to diversify into alternative investments, certain key trends and drivers emerge. This article explores some of the historical alternative investment trends and their drivers for the rapid growth in alternative asset investments for funds.

Alternative investments have gained popularity among hedge fund managers over the past 50 years. These investment trends have included a variety of asset classes, such as real estate, private equity, commodities, and more recently, cryptocurrencies. 

In the 1970s, hedge funds were primarily focused on equities and fixed income investments. However, as the industry matured, hedge funds began to seek out more diversified and uncorrelated sources of returns, leading to increased allocations to alternative investments.

In terms of dollar terms, Preqin estimates that hedge fund allocations to alternative investments have grown from less than $10 billion in the 1990s to over $2.5 trillion as of 2021. This represents a significant increase in the amount of capital allocated to alternative investments by hedge funds over the past several decades.

As a percentage of total hedge fund AUM, Preqin estimates that allocations to alternative investments have grown from less than 5% in the 1990s to over 70% as of 2021. This reflects the growing importance of alternative investments in the hedge fund industry and the increasing recognition of their potential to generate alpha and manage risk.

Overall, the growth in hedge fund allocations to alternative investments over the past 50 years reflects a broader trend towards diversification and seeking out new sources of returns in the face of changing market conditions and investor demands.

Here is a brief review of some of the major alternative investment trends for hedge fund managers for the past half century, and a synopsis of key factors influencing the emergence of new classes of alternative investments.:

1. Real Estate: Real estate has been a popular alternative investment for hedge fund managers for many years. According to a report by Preqin, real estate made up 16% of the alternative assets held by hedge funds in 2019. The Global Financial Crisis of 2008 led to a surge in distressed real estate investments by hedge funds, which has continued to be a popular strategy in the years since. (Source: Preqin, “Hedge Fund Assets and Performance Update: December 2019”)
2. Private Equity: Private equity has also been a popular alternative investment for hedge fund managers, with many funds investing in private equity firms or directly in private companies. According to a report by Bain & Company, global private equity assets under management (AUM) grew from $500 billion in 2000 to $4.5 trillion in 2019. (Source: Bain & Company, “Global Private Equity Report 2020”)
3. Commodities: Commodities, including precious metals, energy, and agriculture products, have been a popular alternative investment for hedge funds in recent years. According to a report by Preqin, commodities made up 7% of the alternative assets held by hedge funds in 2019. (Source: Preqin, “Hedge Fund Assets and Performance Update: December 2019”)
4. Hedge Funds of Funds: Hedge funds of funds, which invest in a portfolio of hedge funds, have also been a popular alternative investment for hedge fund managers. However, the popularity of these funds has declined in recent years due to increased scrutiny and lower returns compared to direct hedge fund investments. (Source: Financial Times, “Hedge fund of funds industry shrinks to smallest size since 2004”)
5. Cryptocurrencies: Cryptocurrencies, such as Bitcoin and Ethereum, have emerged as a new alternative investment for hedge fund managers in recent years. According to a report by Preqin, 21% of hedge funds surveyed in 2020 reported investing in cryptocurrencies or related assets. (Source: Preqin, “Hedge Fund Insights: Cryptocurrency Funds”)

Hedge fund allocations to alternative investments have grown significantly over the past 50 years, both in dollar terms and as a percentage of total hedge fund assets under management (AUM).

Underpinning the phenomenal growth of alternative investments, we can see some of the key criteria that have been used to catalyze new asset class investments:

Low correlation with traditional assets: Fund managers look for alternative assets that are not closely correlated with traditional asset classes like stocks and bonds. This helps to diversify their portfolios and manage risk more effectively.

Potential for alpha generation: Managers seek out alternative assets that have the potential to generate alpha, or excess returns, compared to benchmark indices or other investments.  This is important as fund managers pride themselves on their ability to out-perform benchmark returns, and charge accordingly.

Liquidity: Managers must ensure that the alternative assets are liquid enough to match their investors terms. This can be particularly important in times of market stress or when there is a need to rebalance portfolios. In many alternative investments, liquidity is restricted so this is a key consideration for managers. The liquidity considerations are often tied to investment timelines and exit points. Of course, some alternative assets may have longer holding periods or may require a longer-term view in order to generate returns.

Risk management: Of course, while managers seek to capture alpha from their alternative investment strategy, they need to uphold their reputation for adroit risk management.  Investors need to be assured that the proposed alternative investments’ risks are known and have an adequate management plan around them. Typically this is a key component of fund due diligence.

Regulatory considerations: Certain asset classes have highly restrictive, or undefined regulatory structures. Moves into new alternative assets are often accompanied by changes in a regulatory environment. The regulation can be seen as providing both the framework for investing, but also an element of alternative risk/reward for investors seeking alpha in new markets.