The Growth of Alternative Investments: A Q&A with Craig Peterson, Simon Lenney and Dan Smith

In JP Morgan’s 2022 Global Alternatives Outlook report, a key point of discussion is the need to adapt to and embrace a “hybrid model for investing in a changing market environment," just as we have embraced the likes of hybrid working and hybrid shopping in response to the events of the last several years.

Article main image

The report points out that “facing higher inflation and low but rising interest rates, investors will find it increasingly difficult to generate stable returns through the public markets alone."

Meanwhile, research from Cerulli Associates found that an increasing number of financial advisors are looking to diversify their clients’ portfolios with alternative investments. 70% of survey respondents stated “reducing exposure to public markets” as the core reason for alternative asset allocation, whilst 66% were aiming for “volatility dampening” and “downside risk protection."

What’s more, a Connection Capital survey revealed that high-net-worth investors (HNWIs) are already including much higher weightings of alternative assets in their portfolios when compared to five years ago. 74% of HNWIs are now allocating more than 10% of their portfolios to alternative investments, up from 68% in 2021 and 50% in 2018.

With an evident increasing appetite for alternative investments, in the following Q&A, Craig Peterson (Director, CARLTON Bonds), Simon Lenney (Chairman, CARLTON Bonds) and Dan Smith (Head of Investor Relations, CARLTON Bonds) discuss the reasons behind their growth, covering the role of alternative assets in investing for impact and how investing into alternatives can be done in a tax-efficient manner.


01. It's clear from the data that the appetite for alternative investments is on the rise. What are the reasons for this?

Craig Peterson: Many experienced investors have been aware of the potential of alternative investments for some time, but it’s both positive and interesting to see that demand for alternatives has been growing more rapidly as of late. 

Put simply, I believe this is at least due in part to investors becoming increasingly disillusioned with the performance of mainstream assets. The equities market has been highly volatile and interest rates have plummeted whilst UK inflation has been soaring, reaching 9.2% in December 2022. When inflation is at this level, the value of cash savings is at risk of considerable erosion.

The traditional 60:40 stocks to bonds portfolio make-up that has been favoured by investors and advisors for years has also started to lose traction as it fails to keep pace with today’s market conditions. Investors will naturally look at what other options are available.

Dan Smith: I have had many conversations with experienced investors recently and there’s a recurring thread through many of them – they’re considering altering the weighting of their portfolios in order to somewhat reduce exposure to more mainstream assets. As Craig highlighted, many of these assets have been substantially affected by the current unprecedented market backdrop. 

It’s important to point out that diversification is key here, and listed equities for example can still have a core role to play in an investors portfolio, particularly over the long-term. Vanda Research highlighted recently that private investors invested $25 billion into tech-heavy US equities on average each month during Q2 of 2022, even though the US markets have been in turmoil. There’s belief in long-term recovery and gains.

But it’s key that investors at least explore what’s possible within the alternative space. As JP Morgan pointed out in their Global Alternatives Outlook report, experienced investors with the appropriate appetite for risk should start to consider incorporating assets uncorrelated with mainstream options into their portfolios.

And it’s also worth noting that the term alternative investments does not automatically mean niche assets such as fine art, fine wine or vintage cars. These are of course appealing to certain investors with a passion for and particular interest in the asset, but they are only a small example of alternatives.

There is such a wide selection of alternative investments available today, from highly-publicised cryptocurrencies – which due to their renowned volatility may not be the right choice for an investor searching for volatility dampening, for example – through to direct lending options such as property bonds, meaning it’s likely there will be an alternative asset to suit most experienced investors’ portfolio. 

Simon Lenney: It was also interesting to see in a recent survey from AssetTribe that investors have become more comfortable in using technology to invest, with respondents now twice as likely to use online platforms to make investments. 

Technological advancements that have brought rise to platforms offering easier access to alternative investments for which access was once much more limited can certainly be attributed in part to the democratisation and subsequent growth of alternatives, helping to feed the aforementioned growing appetite.


02. What methods of tax-efficient investing are available when investing into alternative assets?

Craig Peterson: This is entirely dependent on the asset itself and which tax reliefs it’s eligible for, but fortunately there are a number of tax wrappers that mean investors can access alternative assets tax-efficiently. Three of the main wrappers available are the Innovative Finance ISA (IFISA), Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

Just as cash savers can be drawn towards the Cash ISA and equity investors to the Stocks and Shares ISA, the IFISA was established to open the tax-free ISA wrapper up to alternative assets such as peer-to-peer loans and debt-based securities for the first time. 

Then there’s the EIS and SEIS, which each offer investors into high-growth, early-stage companies several generous tax reliefs that help to balance their portfolio to achieve maximum positive impact. 

Dan Smith: Holding alternative assets in an IFISA means they’re completely free from income and capital gains tax, forever. 

The EIS and SEIS offer up to 30% and 50%  income tax relief respectively, along with a whole host of others, including capital gains tax exemption and loss relief. These are all incredibly powerful in mitigating some of the risks associated with investing into startups. 

The tax reliefs available via the SEIS are slightly more generous than the EIS due to the earlier-stage and therefore riskier nature of SEIS-eligible companies.


03. Why is tax-efficiancy a priority now more than ever?

Simon Lenney: The current economic backdrop is somewhat unprecedented, not just in the UK, but globally. As Craig mentioned previously, inflation has been rising exponentially.

At the same time the global markets are being expectedly reactive to recent events, with performance unpredictable and volatile. It’s clear investors should be doing what they can to maximise target returns and minimise downside risk, and investing tax-efficiently is critical here.

Dan Smith: To truly appreciate the impact tax incentives such as the IFISA can have, consider that to achieve 9% outside of the IFISA’s tax-free wrapper (a figure often targeted by the likes of property bonds) this would equate to a Gross Equivalent Return of over 16.4% for additional-rate taxpayers. 

As an example of the EIS at work, if an investor were to pledge £50,000 to an EIS opportunity, they would be able to claim up to £15,000 back by a deduction from that or the previous year’s income tax bill. 

For SEIS, pledging £40,000 to an SEIS opportunity would mean they have the option to claim up to £20,000 back from their current or previous year’s income tax bill. 

Of course there’s risk involved with these investments – particularly with the EIS and SEIS, which are focused on early-stage investing – but the reliefs can certainly help to mitigate it.


04. What role do alternative invesments have in investing for impact?

Craig Peterson: Just like interest in alternative investments, ESG (Environmental, Social and Governance) and impact investing are also on the rise, with more and more investors concerned with their investments creating a positive social, economic or environmental impact as well as generating attractive returns. 

I recently read in Big Society Capital’s Market Sizing Report that the value of social impact investing sits at £6.4 billion as of 2020, up from £833 million in 2011. That’s an eightfold increase in investors wanting to use their capital to do good in less than 10 years – it’s clearly a huge focus.

And investing for impact and alternative assets can certainly go in hand-in-hand. With a “green IFISA” you can help to fund green energy and infrastructure projects. Or considering venture capital, many EIS and SEIS-eligible early-stage businesses are often high-growth. This means they’re on a trajectory to create jobs whilst simultaneously achieving their core objective, which could be in anything from renewable energy, through to more social-focused goals centred on the likes of education and housing.

Looking more closely at the topic of housing, property should be an important consideration for experienced investors searching for an alternative asset that has the potential to generate a positive impact across the board.

Simon Lenney: That’s certainly true. It’s no secret that the UK has faced an undersupply of housing for decades; an undersupply that has been exacerbated by the heightened demand for homes we’ve witnessed post-Coronavirus lockdown. 

The UK Government has been clear that small and medium-sized housebuilders will be crucial in increasing housing delivery. It was in their Fixing Our Broken Housing Market white paper that they highlighted one of the core problems with the market was “a construction industry that is too reliant on a small number of big players."

There’s an incredible opportunity here for experienced investors to play a role in closing this widening gap between supply and demand through the likes of property bonds and the property-backed IFISA, supporting SME housebuilders with the alternative finance needed to aid them in delivering much-needed housing.

But the positive impacts don’t stop at the provision of new homes. SME housebuilders create local jobs, with the housebuilding sector maintaining close to 750,000 jobs across the UK. They can also aid in the regeneration of communities by restoring brownfield land and delivering mixed-tenure developments which cater to a wide variety of home-movers and can potentially make housing more affordable to more people.


Adding alternative investments to your portfolio

Building a diversified portfolio with a variety of assets that is able to better withstand market turbulence has never been more important. And it’s clear from the growing appetite for alternative investments that they could be a key addition to an experienced investor’s portfolio to aid in balancing volatility and maximising potential returns.  

Whether it’s property – which has proven itself time and again to be a resilient asset with excellent growth potential – or early-stage, high-growth startups, it’s crucial that investors explore the options and consider how they could compliment their portfolio’s objectives and help to make their capital work harder.