Alternative investments, also known as “alternatives” or “alts,” are generally considered investments in asset classes other than stocks, bonds, and cash. There is a robust list of alternative investments, ranging from tangible assets like art and precious metals to financial assets like venture capital and real estate investments.
Alternative investments aren’t traded on public markets like stock exchanges or OTC. Instead, they’ve traditionally been invested through more exclusive channels like Portfolio Management Services and Alternative Investment Funds.
Since alternative investments tend to have lower correlations to traditional investments, they are primarily used to diversify an investment portfolio and provide returns that may differ from conventional assets.
- For large institutional investors with a tolerance for illiquidity, alternative investments could include a combination of hedge funds, private equity, alternative credit, and real estate.
- For individual investors, the alternative investment universe may consist of all of these and even vintage cars, rare wines, fine art, etc.
What are Different Types of Alternative Investments?
Alternative investments are worth considering if you want to diversify your portfolio and achieve higher returns. However, alternative investments aren’t for everyone. Due to the diversity of available assets and the nuances and regulations associated with each, you must understand the market well before putting any money into it.
Types of alternative investments you might be interested in exploring:
Investing in commercial or residential real estate can be profitable as a short-term or long-term investment strategy. For example, you can purchase properties below market value, renovate and then sell these properties for an immediate profit or you can purchase rental properties and earn consistent monthly income from tenants.
The downside is real estate investing generally requires a significant initial investment. You may get a bank loan to cover the purchase price, but you’re responsible for other costs associated with buying a property, like down payments and closing costs. Additionally, you’ll need cash to maintain and fix up properties you’re flipping or renting.
An alternative way to invest in real estate is through Real Estate Mutual Funds or Real Estate Investment Trust (REIT). It can reduce the amount you need to start investing. In addition, since real estate tends to appreciate over time, the equity you gain from buying and holding real estate can be a powerful asset.
Venture capital is putting money into a small business or startup, which is felt to have great potential for growth in the long run. This investment strategy can occur at different stages of a business cycle. The first is investing in the early stages of companies with an innovative business idea with high growth potential, commonly referred to as angel investment.
The second is financing or investing in companies with proven business models with a suitable customer base and positive cash flows or profits, commonly referred to as growth equity. These companies have the opportunity to grow by adding new production facilities or through expansion, but they don’t generate sufficient cash flows from their operations to support their growth plans.
The other strategy is buyouts, which consists of financing established companies that require money to restructure and facilitate a change of ownership. Buyouts include making a public company private.
The last strategy is distressed investing, which involves investing in companies in financial distress. The capital is usually used to pay debt and restructure the company.
Private equity generally involves buying shares in companies not listed on a public exchange or purchasing shares of public companies to make them personal. Private equity can apply many strategies that may help provide money to companies at different stages of their development.
Private debt refers to investments not financed by banks, i.e., a bank loan or traded on an open market. Both public and private companies can borrow via personal debt.
Private debt is leveraged when companies need additional capital to grow their businesses. The companies that issue the capital are called private debt funds, and they typically make money in two ways: through interest payments and the initial loan repayment.
If you’re a seasoned investor with plenty of cash, you can diversify your portfolio by investing in hedge funds. This investment strategy works similar to a mutual fund in that you’ll pool your money with other investors to invest in securities and other instruments.
Hedge funds have a manager overseeing the fund and choosing the best investment strategy. Hedge funds have a more aggressive investment approach, which often means higher returns on your investment. Hedge funds are only for wealthy investors. This investment typically requires a minimum investment of 50 Lacs or more.
Structured products usually involve fixed income markets that pay investors dividend payments like government or corporate bonds and derivatives, or securities whose value comes from an underlying asset or group of assets like stocks, bonds, or market indices. Examples of structured products include Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDO).
Structured products can be complex and sometimes risky investment products but offer investors a customized product mix to meet their individual needs. They’re most commonly created by investment banks and offered to hedge funds, organizations, or retail investors.
Commodities are tangible assets that include consumer products like base metals, precious metals like gold and silver, energy products like crude oil and natural gas, etc. These types of commodities are known as ‘Hard commodities. Hard commodities are extracted from the earth and have a long shelf-life. Other commodities known as “Soft Commodities,” such as cotton, sugar cane, and coffee, are produced from the earth and cannot be stored for long periods. Investors can buy and sell commodities directly on the stock market or via derivatives such as Futures and Options. In addition, commodities provide a hedge against inflation.
Artwork and Collectibles
Artwork and collectibles are alternative investments that require market knowledge and patience. It could be challenging to predict what would be the value of artworks and collectibles after some time, say five years or longer. Since it’s hard to judge demand and their appeal down the line, this investment is a shot in the dark if you don’t know what you’re doing. In addition, there is a danger of counterfeit products. Other factors like wear and tear make artwork and collectibles illiquid and create price depreciation. If you invest in precious artwork and collectibles, buy something unique and certified.
What are the Unique Features of Alternative Investments?
Alternative investments cover a wide range of assets and strategies. Generally speaking; they are characterized by:
- Low correlation to traditional investments like stocks and bonds.
- Potential for higher returns than conventional investments.
- More esoteric and often illiquid assets.
- Longer locked-in periods.
- Usually, higher minimum investment requirements.
- Suitable for only a few investors with the aptitude for bearing high risk.
What are the Key Risk Considerations in Alternative Investments?
- Transparency: Alternative investments may not offer the same level of transparency as traditional investments, which must provide frequent and full disclosure.
- Liquidity: Alternative investments typically have a lockup of capital, and you may not be able to redeem your investment for an extended period.
- Fees: Alternative investment fees are generally higher than those associated with traditional investments.
- Leverage: Alternative investment strategies may use some form of leverage and magnify the impact of risk and return.
- Concentration: Alternative investment strategies may be highly concentrated in a few funds or holdings.
Conclusion: When Should You Invest in Alternative Investments?
Investing in alternative investments is a complex process. It involves many factors, such as the risk of the investment, its return potential, and its price volatility. However, they could be a part of an investment portfolio; 1) if you need alternative sources of return, income, and diversification, and 2) investments that are less correlated to traditional markets.