Can diversifying into alternative investments help investors navigate market volatility? LGT Wealth's Vislavath explains

Alternative investments do not belong to conventional investment categories such as stocks or bonds; rather, they represent a diverse range of financial assets, such as private equity, private credit, hedge funds, real estate, venture capital, commodities, and collectables. 

These assets have grown in popularity in recent years, especially as investors seek to diversify their portfolios by allocating a portion to alternative investments to enhance their long-term investment approach.

Not only do alternative investments have the potential to diversify a portfolio of traditional assets but often deliver performance that is not correlated to traditional markets, helping investors navigate volatility.

According to recent industry reports, the alternative assets market in India, currently estimated at $400 billion AUM, is projected to grow 5x to $2 trillion over the next decade. 

Globally, the alternative investment market has reached an estimated $25 trillion AUM and continues to expand as the investor base and their allocations to private markets increase. Even though India now stands as the world’s fourth-largest economy, alternative investments remain underpenetrated at just 4% of GDP, compared to over 10% of GDP in mature markets like the US and Europe, with investors allocating as much as 20% of their portfolio to alternatives. 

This gap presents a significant growth opportunity in India, especially as family offices, high-net-worth individuals (HNIs), and ultra-HNIs increasingly seek non-traditional, higher-yield assets.

Indian investors are participating in alternative investments through allocation to AIFs (Alternative Investment Funds), REITs (Real Estate Investment Trusts), InvITs (Infrastructure Investment Trusts), offshore opportunities through GIFT City-based funds and international platforms. 

Each asset category has unique characteristics in terms of expected return, risk, yield, liquidity, and capital requirements that require a closer look to better understand the different benefits that it can bring to a portfolio. 

While some of the asset categories may serve more of a growth and capital appreciation purpose, others may protect portfolios against inflation and/or provide stable income, while some strategies may offer a combination of both.

Over the years, alternative investments have offered return premiums to investors who were willing to accept greater illiquidity and have been shown to meaningfully outperform public markets over time. 

While access to AIFs has been driven by a mix of macroeconomic, regulatory, and technological forces, the asset class can present its own challenges, requiring an in-depth understanding of the space to evaluate and choose alternatives suitable for investors' risk profiles. 

Our team harnesses its global knowledge and experience to carefully curate a set of high-conviction investment strategies in the alternatives space, designed to help investors in appropriate capital allocation. 

Investors who are starting their journey in the alternatives market can start with shorter-tenured private equity funds, such as those with an average life of five to seven years, which invest in stable businesses with predictable exit scenarios, and private credit funds, which generate cash yield. 

This allocation can be enhanced to long-tenure equity funds of eight to ten years, investing in stellar fund managers with a track record in the fund’s investment strategy. 

There are many nuances in the selection of the fund manager, including, but not limited to, characteristics like having skin in the game, the ability to leverage their experience to back transformational companies poised for growth, the ability to navigate the market dynamics supporting the portfolio companies, and the ability to generate alpha over the investment horizon.

Despite the steady growth in alternative investments, one setback in the past few years has been a slowdown in liquidity avenues for AIF investors due to delayed exit options of the underlying portfolio entities of these AIFs. 

This is expected to improve in the following years as many of these entities will use vibrant capital markets, possibly secondary markets with wider participation, and offer opportunities for investor exits.

Investors who thoughtfully allocate to alternatives - balancing risk, liquidity, and long-term vision - could benefit significantly in the next decade.

The author, Rajini Vislavath, is the CIO of Alternative Investment at LGT Wealth India.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making investment decisions.