Very large amounts of money are held by institutional investors. Life insurance companies, trust banks, pension funds, and government-affiliated financial institutions are referred to as institutional investors. In the case of people who own more than US$100 million in assets, they manage large amounts of money as family offices.

These institutional investors and family offices do not invest only in stocks. All institutional investors and family offices invest in alternatives.

The reason and background behind the preference of alternative investments for institutional investors and family offices are that it allows them to grow their assets even in a recession.

However, there are different types of alternative investments. What kind of alternative investments do institutional investors use? I will explain this in this article.

A Portfolio That Invests in More Than Just Stocks and Bonds Is Optimal

When investing, the saying, “Don’t put all your eggs in one basket,” is very famous. In other words, diversification is the main principle when investing, and unbalanced investments are extremely risky.

However, most individual investors are biased toward a single investment method. Specifically, they invest only in stocks and bonds.

Of course, there are many types of stocks and bonds. Stock investments include global stocks, US stocks, and developed country stocks. However, during a major recession, the value of stocks and bonds can be reduced to less than half. In other words, if you invest in stocks, you will always lose a lot of assets during a recession.

On the other hand, institutional investors and family offices do not invest only in stocks and bonds. This is because the risk is very high when the only investment method is stocks. Therefore, as a way to avoid investing in traditional assets (stocks and bonds), institutional investors and family offices are actively adopting alternative investments.

Institutional Investors and Family Offices Are Investing in Alternatives

The reason why institutional investors are adopting alternative investments is simple. They want to increase their assets regardless of the economic downturn.

For example, hedge funds are well known as alternative investments. The reason why many institutional investors are investing in hedge funds is that they can increase their assets regardless of the economy.

For example, below is a fact sheet on a hedge fund that deals in nursing care real estate in the UK.

February and March of 2020 have positive returns. These were the months when the stock market crashed due to the coronavirus. Nevertheless, the returns were positive.

This kind of asset management is possible with alternative investments. The main reason and background for institutional investors and family offices to invest in alternatives are to reduce risk.

Investment Case Study of the Harvard University Foundation

What do the portfolios of institutional investors and family offices look like? As an actual example, let’s check out the portfolio of the Harvard University Foundation.

The Harvard University Foundation discloses the details of its asset management and portfolio. The portfolio is as follows.

As you can see, they invest not only in listed stocks and bonds but also in many other investments. They invest in real estate, hedge funds, etc., and the Harvard University Foundation invests in alternatives.

Of course, not only the Harvard Foundation but all institutional investors and family offices invest in alternatives. By investing in low-risk investments, they can increase their assets every year.

Institutional Investors Make a Wide Range of Alternative Investments

What kinds of alternative investments are made by institutional investors and family offices? As mentioned above, there are different types of alternative investments. Among them, the major alternative investments include the following.

  • Real estate
  • Hedge funds
  • Private equity
  • Commodities

By owning real estate, you can earn rental income regardless of the economy if you have tenants. For this reason, the purchase of physical real estate is widely known as an alternative investment.

Hedge funds are also alternative investments. All hedge funds are independent of the economy. For example, a hedge fund that invests in stocks will take a short position (sell) as well as a long position (buy). This allows us to earn a return even when stock prices are falling.

On the other hand, investments in private equity and commodities are also alternative investments, although they are not suitable for individual investors.

Private equity is a way to invest in unlisted companies. Since these companies are not listed, you cannot buy or sell their shares freely, which is a very risky method. However, even in a recession, the stock price does not fall.

If you invest in commodities, the price movements are different from those of stock prices. One of the most famous commodities is gold, for example. For reference, the following is the price movement of gold.

Institutional investors and family offices incorporate many of these investment methods. By including different types of alternative investments in their portfolios, they are diversifying their investments.

Hedge Funds Are the Main Investment Destination

Hedge funds are the main investment vehicle for institutional investors and family offices. Although there are many institutional investors who invest in stocks and bonds, hedge funds are the main alternative investments.

In fact, the Harvard University Foundation, which I presented earlier, invests more than 36% of its funds in hedge funds. Hedge funds account for the largest portion of the portfolio.

When investing in real estate, institutional investors can only invest in high-value properties. For example, institutional investors with 1 billion dollars in assets will not be effective if they buy 1 million dollars in properties. Even if it is an expensive purchase for retail investors, it does not make sense for institutional investors or family offices to purchase a $1 million property.

Therefore, the real estate to invest in is limited. Hedge funds, on the other hand, are willing to accept expensive investments without limit. Therefore, investing in hedge funds is more effective than investing in physical real estate.

Also, investing in private equity and commodities is very risky, not only for individual investors but also for institutional investors. For this reason, there are no institutional investors that have the largest percentage of their investments in private equity and commodities.

For these reasons, investing in hedge funds is important for institutional investors and family offices.

Low-Risk Investments Are Possible with Hedge Funds

While there are high-risk, high-return hedge funds that can earn 20-30% annual interest, there are also low-risk hedge funds.

Low-risk hedge funds do not invest in stocks with multiple leverages. Rather, they increase their assets by investing in other than stocks and bonds. Therefore, low-risk hedge funds tend to be the primary investment for institutional investors and family offices that want to earn a steady return each year.

Low-risk hedge funds include, for example, the following investment strategies.

  • Mortgage loans
  • Microfinance
  • Accounts receivable trading
  • Bridge loans

Each hedge fund has different strategies. For example, below is a fact sheet on a hedge fund that offers bridge loans in Europe.

Institutional investors and family offices from all over the world invest in this hedge fund, as large corporations registered in Europe are the clients of this fund.

The financial products offered are bridging loans, so the interest rates are high, and the assets grow at 8-10% every year. Also, there have been no negative return years in the past. Unlike investments in stocks and bonds, low-risk hedge funds are useful for institutional investors and family offices because they can increase assets even in a recession.

Alternative Investments Are a Good Way to Invest

All institutional investors and family offices are investing in alternatives. The reason for this is that they can increase their assets regardless of the economy.

For retail investors, alternative investments, including hedge funds, are unfamiliar. For institutional investors, on the other hand, it is common sense to invest in alternatives. This is because it is very risky to invest only in stocks and bonds.

Also, many institutional investors, such as the Harvard University Foundation, have a high percentage of their investments in hedge funds. The advantage is that they can increase their assets regardless of the recession and are also low-risk.

It is important for institutional investors and family offices to include alternative investments in their portfolios, especially in hedge funds.