The Past, Present, and Future of the Industry

In this lesson, we're going back in time to the very beginning of alternative investments, exploring how the industry has evolved from a single railroad investment to having more than $10tn in assets under management. We'll also take a look at what the future holds for alternative investments, as the industry continues to grow at unprecedented rates.

Although ‘alternative assets’ is a relatively modern term, investment in these types of assets is not a new phenomenon. Some of the earliest examples of private-capital-type investments can be traced back as far as the 1800s, when individuals made investments into projects during the Industrial Revolution.

Restrictions to the financial structure of banks at that time meant that private investments were largely dominated by wealthy families and individuals.

Alternative investments grew in prominence during the 20^th century, particularly after the World Wars when many countries began to rebuild. During this time venture capital became the catalyst for success in private markets. With technology changing the landscape for many industries, venture capitalist investment in new technological developments and entrepreneurial opportunities expanded rapidly through the 1960s and early 1970s.

After the stock market crash of 1974, regulatory change also served to boost the industry; the US Government introduced the Employee Retirement Income Security Act (ERISA), allowing pension funds to invest in ‘riskier’ opportunities. The capital gains tax rate was also reduced to aid recovery from the crash, causing an influx of capital into private equity investments (the term ‘private equity’ superseded ‘venture capital’ in the 1980s as a term used to encompass all investments in private equities). A boom in leveraged buyouts followed in the 1980s and private equity began to appear in the portfolios of mainstream investors, laying the foundations for the industry we see today.

Hedge funds also originate from the mid-20^th century, when the first hedge fund was purportedly developed in New York City in 1949 by Alfred Winslow Jones. He successfully devised a hedging approach that sought to reduce a portfolio’s exposure to market movements, relying heavily on the investment manager’s skill in selecting securities. A.W. Jones & Co. also instituted two other hedge fund hallmarks: the requirement for managers to make significant personal investments in a fund, and a compensation structure that awarded the manager with 20% of fund performance profits.

For many years, the Jones method was known only to a small group of investors. However, in 1966 it was revealed in a Fortune magazine article that Jones had outperformed the best mutual fund over the past five years by a significant margin. With that, the hedge fund industry boomed, and by the early 1980s many new strategy variations had begun to appear in the market.

The alternative assets industry has continued to grow in recent years and is now a mainstay of the modern investment landscape. Industry assets under management (or AUM) are at record highs, and investor and fund manager interest in alternatives has increased steadily over time.