My most recent post dealt with my views on Bitcoin and how I felt it was a speculative investment with little intrinsic value. Yet I’m not a Bitcoin hater, it does have a place in the right portfolio, just like any investment. Speculative investments such as Bitcoin however, should not be a large part of any portfolio because even if they shoot up in value, so does your risk. Other speculative investments recently have included shares in heavily shorted companies like AMC and GameStop, shares in Marijuana distributors as well as SPAC’s. These are in the same category risk wise as Bitcoin: speculative investments. SPAC’s are just money given to a start up with no operations or assets, usually on the faith that the founder has some investment success. Until Marijuana is a Federally legal drug, it will remain on the fringes of investing and remain speculative, each company hoping they don’t get big enough to provoke a direct clash with the government. The most shorted stocks like GameStop and AMC’s risk should be obvious: you are joining a fickle Reddit herd looking to pile into an investment with no guarantee on when they will exit or how long they will remain.

Although the media will focus on one off, massive risk taker who make a big payday, the majority of retail money flowing into these assets when they become popular will probably lose money in the long run. Yet the liquidity that new investors are brining to the market is part of a wider story: the liquidity in everything.

In a great article featured last week in The Economist, the magazine discussed the various ways in which stocks have become more liquid and cheaper to trade over time, especially since the days of high fixed cost fees in the 1970’s. Since that time not only have the commissions gone down and now have approached zero, but the liquidity of stocks has increased just as dramatically.

This is great if you quickly want to get rid of shares, speculate on some bubble shares or you would like to see the democratization of finance and power move from the big Wall Street wire houses to Main Street investors. Liquidity comes with another cost though: potentially lower returns. The equity markets will always offer a decent return and risk spread over assets like bonds over the long term but, as we all know, short term fluctuations can be volatile. The market pays you over the long term for accepting the risk of volatility with the knowledge that over some periods, your investment may underperform. This brings up memories of the late 90’s and early 2000’s when the market was vastly overpriced. From the peak in the year 2000, US equities as measured by the S&P 500 fell 40%, saw a new surge from 2003 to 2007 and then fell another 50% during the crisis. It wasn’t until 2013 that the S&P 500 started to push sustainably ahead of its year 2000 highs. This period came to be known as the “lost decade” of investing.

One tool long term investors put to use is the cyclically adjusted P/E ratio or CAPE which looks at the real profits of the S&P 500 over the last 10 years and the price multiple of that figure that the index is currently trading at. Names like Warren Buffet and Yale Economist Robert Shiller helped make this gauge famous as they use it as an indication on whether the market is overvalued.

The current CAPE ratio for the S&P 500 is at 35.6, the highest it has been since the year 2000. This has led to many calling current valuations bubbly and long term investors often point to the fact that the higher the CAPE ratio you buy at, the lower your returns will be over the subsequent 10 year period.

Shiller did recently come up with a new calculation that takes into account low interest rates and shows that the stock market may not be so overvalued after all but neither of these measures take into account liquidity. Liquidity is an important part of return because the less liquid an asset is, the higher the illiquidity premium is. This rewards patient and long term investors who can take advantage of this feature. The classic example of where this is put to use is with college endowments who place about a quarter of their funds into private equity. They are able to get a few percentage points higher return compared to the stock market over time for these types of assets due to that illiquidity. The asset managers who pitch investments to these clients regularly highlight this feature.

Liquidity Everywhere

This may be starting to change though. Private equity for the moment is only for the wealthy. You have to prove an income of $200k or more annually or have a net worth above $1 million apart from the value of your primary home. These investors are called accredited investors. Many people are not aware that there is still an entire asset class that is legally barred from access to most investors. This is because the government has decided that these investments are too risky and complicated for ordinary retail investors to reliably understand and leaves many open to manipulation by con men and women who want to exploit this lack of knowledge for their own gain.

Yet there are being holes poked in this veneer:

• In August of 2020, the SEC provided guidance on how licensed finance professionals could now be counted as accredited investors as well as how smaller institutions and family offices could meet the institutional requirements.
• In addition, the JOBS act of 2012 created a new loophole for private retail money through what is called a mini IPO or Reg A+ offerings, which allow smaller start up companies to raise up to $50 million.
• Defined benefit retirement funds, usually classified in private industry as 401(k)’s have technically had access to private equity funds for some time but due to lawsuits about imprudence, they have shied away. Last year however, the Department of Labor clarified its position and announced that private equity could be included in sponsor plans. This could open a huge swath of retail money to invest in alternative assets.

These are the cracks in the edifice of the wealthy only having access to illiquid and this higher returning opportunities. Although the lines are not always clear about who is allowed to invest, be it retail or accredited investors, a number of companies have popped up to exploit this growing an niche market in alternative investments that should at least be considered if you are the type of investor who is looking at Bitcoin:

• Yieldstreet – Yieldstreet was designed the the issues of access to private equity mentioned above in mind. The platform caters mostly to accredited investors who can access investments in direct commercial real estate, ship financing, litigation financing, and even art. Investments tend to start at around $10,000.
• Fundrise – Fundrise focuses on real estate only. Real estate is another illiquid asset that doesn’t change hands very often so benefits from the lack of liquidity. Although REITs are liquid investments and do tend to mirror the returns of private real estate in the long run, if you don’t want the stress of seeing prices on a day to day basis, cheap private real estate funding could be an option for you.
• Masterworks – For years I have been seeing articles here and there about how fine art has been outperforming many markets. Masterpiece allows you to invest in a price of ownership of art made by world renown names like Warhol, Basquiat and Condo. They are happy to show off that art by “blue chip” artists has generated a return double that of the S&P 500 over the last 20 years.
• LendingClub – LendingClub is just example of the peer to peer lending market. This essentially cuts out the banks as the middle man and allows you to lend directly to consumers for anything from startup ideas to debt consolidation. I had an account with LendingClub a while ago but found that I personally didn’t like the involvement and return that a smaller account required. They do have an option that if minimum amounts like $50,000 were invested you could have your capital redeployed but this size wasn’t attractive to me at the time, maybe this could be an option for some readers though.
• AngelList – For those that specifically want to target the startup tech sector, AngelList is a viable option. There are considerable risks in these investments but that’s because the returns could be meteoric. $10,000 invested in the first round of investing in Facebook in 2004 could now be worth $250 million by now so some would love to take that risk. Knowledge of new products will challenge traditional investors though: convertible notes, preferred equity and SEC regulations will be regular topics in these investments. Other sites in this niche include Seedinvest and Wefunder.

Some of those who invested in Bitcoin years ago may have thought if it could just become widely used and available, then that usability could provide a return in itself. If you want to get into the next phase of hot investing, I would look no further than other alternative investments in addition to Bitcoin such as those featured on the sites above. Just as the public moved into stocks, alternative assets could start to gain more traction and be the next investment to get their day in the spotlight. To beat the market you will need to move before the crowd does.

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