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What Are Alternative Investments?

Alternative investments are becoming more prominent and accessible worldwide, Learn what makes them appealing as an addition to your investment portfolio.

last update Wednesday, November 02, 2022





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Alternative investments are gaining popularity among investors as promising instruments for generating income, increasing returns, and diversifying portfolios. However, it is understandable if you don't know what an alternative investment is because the term is very general. Over the next five to ten minutes, this article will help you better understand what alternative investments are and how they apply to investment strategy and wealth building.

What Is an Alternative Investment?

Also known as alternative assets, alternative investments are financial assets that exist outside the mainstream asset classes, like stocks, bonds, and cash. The alternative asset class offers a broad collection of diverse unregistered investments. As a result, thoroughly investigating assets in this category is challenging. But individual and retail investors are gaining more access to alternative investments.
Global alternative assets under management reached $10 trillion in 20201. And experts project that the volume will increase to $14 trillion by 20232. As a result, alternative assets are ending up in more investment portfolios worldwide.

What are Some Alternative Investment Types?

Most investors gain exposure to institutional quality alternative assets through the following four types.

Private Equity

With a 36% share ($6.5 trillion) of the $18 trillion in alternative assets, private equity is the largest category of all alternative investments 3. Private equity involves capital investment in private companies that are not available for trade on the NYSE, NASDAQ, or any public exchange. The capital investment may take the form of venture capital, growth capital, or buyouts.
H3: Real Assets
Real Assets encompass many asset classes, including real estate, farmland, natural resources like oil and iron ore, commodities, collectibles, intellectual property, and infrastructure.

Hedge Funds

Hedge funds feature highly skilled and experienced fund managers capable of using complex and frequently risky strategies to reach their goal of higher returns. These private, pooled funds are exclusively available to sophisticated investors like mutual funds, pension funds, endowments, and high-net-worth individual investors (accredited investors).

Structured Products

Also known as market-linked investments, structured products are pre-packaged structured investments linked to fixed-income markets that yield dividends from a basket of securities, market indices, bonds, or derivatives. For example, credit default swaps (CDS) and collateral debt obligations (CDO) are structured products4.

What are Some Alternative Investments Benefits?

Although alternative investments can vary significantly in nature and protocol, they share some commonalities that could benefit your investment portfolio. These advantages include the following:

Less volatility

Alternative investments have less exposure to the major markets, making them less sensitive to market volatility5.

Low correlation

Low correlation to traditional asset classes is a dominant selling point for alternative investment solutions. For example, the real estate market's performance is virtually separate from the equity market6.

Possible greater returns

Alternative investments offer higher returns as compensation for taking higher risks.



Hedges against inflation

Real estate, oil, and gold are examples of alternative investments that are potential hedges against inflation by nature.

Diversification

Since alternatives have a low correlation to stocks and bonds, you can improve diversification in your portfolio by adding an alternative asset solution.

What are Some Alternative Investment Drawbacks?

Like any asset class, alternative investments come with their unique cautionary characteristics. Two of the most prominent concerns are the lack of regulation and transparency.
Since the SEC doesn't regulate most alternatives, this can restrain the amount of information available to investors. However, alternative investments are under the Dodd-Frank Act's purview, which gives the SEC the authority to review their practices.

Another thing you should be aware of is many alternative assets are illiquid. Since most are not publicly traded, many alternates don't get a regular market price, making it difficult to determine the value for buying or selling purposes. This dilemma is why many hedge funds and private equity funds set defined periods that prohibit the withdrawal of funds. In addition, the higher risk factor may be too much for some investors.

How to Buy Alternative Assets

As you can see, buying alternative investments is more involved than purchasing traditional asset classes. Of course, the higher return potential and keen diversification are desirable attributes. But the risks can be sobering. As a result, if you aspire to venture into alternative investment solutions, you must commit to many hours of due diligence and exhaustive research.
If you are an accredited investor, it may be more advantageous to invest through an investment firm specializing in alternative investment strategies backed by real estate, farmland, or commodities. These firms generally have the expertise to properly study and evaluate the risk/return potential of these assets for the purpose of providing an alternative investment portfolio solution or investment strategy.

FAQs About Alternative Investments

What are some alternative investments examples?

Alternative investments offer individual and institutional investors viable opportunities for building wealth. The most popular alternative assets are
  • real estate,
  • venture capital,
  • private equity,
  • managed futures,
  • intellectual property,
  • farmland,
  • and collectibles like art and rare coins.

What is the best alternative investment?

From a general perspective, real estate is the best alternative investment for several reasons.
  • It provides the potential for high returns and
  • low correlation to traditional investment assets like stocks and bonds.
  • But real estate is more transparent and regulated than most alternative assets.

Who can invest in alternative investment funds?

Alternative investment funds are exclusively available to high-net-worth individuals and institutional investors. A high-net-worth investor is a person with an accredited investor designation by the Security and Exchange Commission (SEC). To become an accredited investor, you must prove you have a net worth of over $1 million, excluding your home. Alternatively, you can become one by verifying you have a valid financial professional license or an annual income of at least $200,000 over the past two years or $300,000 as part of a couple.


Sources

1. PWC https://www.pwc.com/jg/en/publications/alternative-asset-management-2020.pdf 
2. Preqin https://docs.preqin.com/reports/Preqin-Future-of-Alternatives-Report-October-2018.pdf 
3. Caia https://caia.org/blog/2022/04/06/state-alternative-investments-2022 
4. HBS https://online.hbs.edu/blog/post/types-of-alternative-investments 
5. Forbes https://www.forbes.com/advisor/investing/alternative-investments/ 
6. Forbes https://www.forbes.com/sites/forbesbusinesscouncil/2021/12/15/understanding-the-upsurge-of-alternative-investments/?sh=709112524b0e

by John Burson

https://www.linkedin.com/in/john-burson-838984119/

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