The world of alternative investments is evolving fast.
With global allocations to alternatives expected to rise by 22 per cent in the next two years, according to EY’s 2024 Global Alternative Funds survey, they have become an important component of portfolios.
Alongside this shift, the approach to managing risks is also changing.
Emerging technologies are reshaping how threats are addressed, but the ongoing global uncertainty introduces new challenges.
What alternatives mean for risk management
Before diving into tools for risk management, it is worth asking: What defines alternative investments from a risk perspective?
Unlike public markets, alternatives tend to be less liquid, harder to price, and much more sensitive to legal risks.
They can also carry concentration threats, especially if a portfolio leans heavily on a small number of assets or sectors, increasing exposure to individual asset performance.
With this in mind, the golden rule of investing becomes even more crucial: Do not bet everything on one asset.
For example, private credit may offer high returns but can be hard to sell quickly if the market gets tough.
On the other hand, while digital assets can bring big profits, they come with high volatility, like a recent market fall – here stablecoins can serve as a reliable hedge.
So, diversification remains important not just when choosing alternative investments alongside traditional ones but also within the category itself.
In other words, even within the alternative type, it is essential to spread risk across different types of assets.
Keeping up with new laws
At the same time, it is essential to remember that the rules of the game across the continents are also changing rapidly – as is the industry itself.
Although regulation is constantly updated to achieve a clearer market, it still directly affects how investment funds operate and how they adapt to manage risks.
For example, in the UK, the government is updating regulations for alternative investments, because since the alternative investment fund manager regulations were introduced, market participants have pointed out operational challenges with the legislative thresholds.
And this feedback is currently driving discussions on potential regulatory adjustments to address these issues.
For managers, this means one thing: they need to be on alert all the time.
New laws require not just to be aware, but to quickly rebuild internal processes and control framework.
Especially now that digital assets are becoming an increasingly visible part of the financial system.
Emerging technologies as a way to reduce risk
With the rise of new technologies, asset managers now have powerful tools to manage risks better.
One big shift is the tokenisation of assets – basically turning real-world investments into digital tokens using distributed ledger technology (DLT).
The good news is that this tech can actually make investing safer and increase investors protection.
Tokenised assets can be traded more easily, making them more liquid and solving one of the main problems of alternatives.
In addition, DLT adds transparency, helping investors see more clearly what they own and how it is performing.
And this is not just theory.
The global market for DLT-based use cases is skyrocketing: from $1 to $103bn (£77.3bn) in just 10 years, Statista data shows.
Another big trend for the alternatives sector is artificial intelligence and big data analytics.
More than 50 per cent of alternative investment firms are actively integrating these tools into their jobs, according to a survey by fintech firm Dynamo Software.
With their help, managers can build more accurate forecasting models using much more data beyond numbers.
It can even be high-quality information, such as news or market sentiment, that is not that easy to digitise.
AI also allows the automatic monitoring of dangers in real time, which is especially important for volatile markets operating 24/7, such as cryptocurrencies.
There, procrastination can be expensive, and automation means being one step forward.
Simply put, AI and big data transform risk management from a ‘reaction to a crisis’ into a smart early warning system.
Riding the wave of change
With these new tools becoming smarter and, therefore, more popular, I believe that the future of risk management is entering a whole new era.
In this period, technology will play the main role, and risk managers have more ways than ever to stay ahead of the curve.
However, new trends of risk management raise the stakes.
For example, although tokenisation will continue to bring new levels of liquidity and transparency, fresh challenges can arise.
Digital assets also have their downsides, and asset managers will have to learn how to operate with smart contract bugs or how to store them safely and properly.
AI and machine learning development will also be used more.
Nevertheless, both AI and ML have drawbacks; many models still have biased algorithms or unreliable data on which they operate.
In the end, we have to find a way to manage them with care, to not create even more risk.
Julien Wolff is an executive director and head of risk management at 6 Monks