The field of alternative investments is significantly wide. It covers a plethora of asset types but for the sake of understanding, here are the basics that every aspiring investor should know.
This type of investment features all types of investments that anyone can think about apart from three traditional asset classes which include stocks, cash, and bonds. In most cases, alternative investment is known to promise great returns although it is also unpredictable. Its volatility and unpredictability come as a result of a lack of regulations in most parts.
Additionally, its liquidity potential is also mysterious and somewhat undependable. Taking all these factors into consideration, it can be concluded that alternative investment is quite risky. The most common assets that make up alternative investments include private equity, art and antiques, commodities, venture capital, real estate, derivatives contracts, and hedge funds.
What Is Alternative Investment Made Up Of?
Most of the available alternative investment opportunities are not for the small spenders since only the wealthy can afford to invest in them. Some requirements like expensive minimum investment fees make the entry barrier of this asset category which is considerably high for the average investors.
Furthermore, investors cannot easily change alternative assets into cash as quickly as they can when they have invested in their traditional counterparts. In the end, due to lack of regulation, high-risk levels, and complexity, only the accredited and wealthy institutions or individuals choose to spend on this type of investment.
Nevertheless, there is an advantage associated with alternative investments in spite of the high initial minimums. Transacting and conducting businesses using alternative investments is cheaper compared to traditional assets due to their low gross revenues.
Top Examples Of Alternative Investments
The importance and need for an investor to grow their portfolio pushes them to implement different investment strategies. One of the best methods of portfolio diversification is incorporating alternative investments. Here are some of the most popular investments in this category.
Starting from its multiple trading strategies up to conducting transactions in non-traditional markets, the promises and potentials associated with hedge funds are not readily available anywhere else. Some of the factors that make hedge funds uniquely attractive include:
- They are less restrictive on investments
- They implement the best trading strategies and experts to add great value to investments
- Investors are protected from market volatility
- Investors are provided with a wide opportunity set
- They can be readily classified into five categories which include Global Macro, Managed Futures, Long/Short Positions, Distressed, and Multi-Strategy
This alternative market is different from its public equity counterpart. It differs in the same way as its returns together with diversification differ. Investors can benefit from private companies to enjoy enhanced profits. Here are some of the notable benefits:
- The involved investments perform well whether on an absolute of a risk-adjusted basis
- It adopts and implements a long-term strategy on investments when compared to the quarterly earnings that are synonymous with the public market
- Private equity investments are lucrative irrespective of a company’s current stage in its life cycles that include growth periods, venture capital, reorganization, and buyout
The businesses and companies that relate to natural resources have always been profitable starting from the days of early civilization. Things like industrial metals, precious metals, energy, and agricultural products will always be great investments.
Examples of Commodity Investments
Index fund is an index that has a list of commodity assets.
- The commodity funds have a personal relationship and link with commodity assets through direct investment in the underlying asset.
- Another type is the Futures-based Commodity Funds. This category uses futures contracts to elaborate and shed light on commodities. Futures contracts are considered to be the investments in this instance and not the underlying commodity asset. It is a high-risk investment since the futures contracts market is significantly unstable.
- Real estate is an excellent option for any investor seeking to diversify their portfolio. The investment started as a favorite only for the wealthy but it has evolved extensively to accommodate everyone who wishes to invest in it. Currently, the low entry requirement offered by the publicly traded exchange-traded funds (ETFs) and trusts for all types of real estate investing has made it quite attractive to investors.
- Art and antiques category is popular for its unchanging value even when inflation strikes. Items in this category comprise antiques, art, gems, and collectibles. They are an excellent investment option particularly for people with other assets that are easily affected and influenced by market conditions.
- Managed futures are investments where the portfolio of futures contracts are actively managed and transacted by professionals. Most funds and institutional investors mostly use managed futures to guarantee both market and portfolio diversification.
- Derivatives contract is an agreement between two parties and it gets its value or price from an underlying asset.
- Cryptocurrency is the latest type of alternative investment. Even though many refer to it as a high-risk investment, its returns are significantly high. Investors who look at the long-term investment strategies should consider investing in crypto since it has a significantly high chance of surviving even the worst financial crisis.
Alternative Investment Benefits
There are various moments when owners of these alternative investments feel great about their investment choice and that comes whenever the time to pay taxes comes. These investments attract more gentle tax loads when compared to conventional investments.
Alternative investments depend on various aspects that can lower or raise their value. Whenever the value is reduced, investors can buy them at a much cheaper rate to hold over a certain period. They can then sell and take the profit whenever the price bumps up.
There is a stringent laid down rule that affects the alternative investments which are referred to as the 2 and 20 fee structure. This translates to a management fee of 2% which the investor pays and a 20% commission rate in the case that the fund extends beyond a particular return threshold.
The risk comes if for any reason the fund performs dismally. The capital invested suffers a sizeable cut when the fund performs badly due to high fees.
Complexities associated with some of the alternative investments can, in some cases, make the planning and execution of business strategies significantly challenging.
On the other hand, some alternative investments do not offer any chance for liquidity. Whenever an investor’s money goes into it, getting it out becomes impossible. Furthermore, the asset class has scarce transparency and when compared with the traditional investments on the same measures, it falls short.
It is quite common to hear strange beliefs associated with alternative investments. Individuals who have no idea about what this asset class entails tend to always make up theories about it. Most of these made-up stories are baseless. The resulting misunderstanding makes many people think that this investment category is strictly meant for the wealthy.
On the contrary, alternative investments are meant for anyone who can be a part of it if they desire to participate.
Another myth states that bonds and stocks are less prone to volatility whenever they are compared to alternative investments. The truth of the matter is that whenever they are considered individually, some of the alternative investments are quite volatile even more than traditional stocks and bonds. However, when considered as a group, alternatives are not in any way worse than other investments.
The issue of volatility, when considered in reality, is more acute in the stock market than in most of the alternative investments.
Another myth states that investors can diversify their portfolio by just selecting a single alternative investment and putting their money on it.
But, the truth of the matter is that in the same way that investing in one stock or mutual fund does not translate to meaningful diversification, investors should not think that investing in just one alternative investment will have major diversification impacts on their portfolios.
Placing one’s investments and money in one alternative investment may provide an investor with access to particular diversification privileges but the risk level is simultaneously multiplied.
Another myth doing rounds in the investment world is that money invested in all alternatives is not accessible. But the truth lies in how liquid an alternative investment has to do with the type of investment in question. Some of the investments make provisions for cash daily like for the case of some alternative mutual funds.
On the other hand, the limited partnerships can place limits on the access to cash from 30 days to over 10 years.
Alternative investments are a great solution for any investor who seeks to try investing in other kinds of assets. Their influence holds great potential of reducing volatility while simultaneously widening diversification and increasing yield.
Nevertheless, before going for any type of alternative investment, the investor is advised to thoroughly choose depending on what he hopes to achieve. Any investor who goes into alternative investments in most cases has a motivating factor that is driving their investment decision.
Some people choose to invest in this category to escape the familiarity of traditional markets aiming to test new grounds. Others dive into this sector since they wish to make a long-term investment since the alternative investments have a great potential for higher returns.
Hence, with alternative investments, the investors are provided with a chance to soften the effect of high-interest rates and inflation on their portfolios through hedging. It is up to the investor to determine what strategy they wish to use to ensure that their portfolio is highly diversified.