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What are alternative investments? How can alternative investments improve your portfolio?

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

last updated Thursday, May 2, 2024
#alternative investment #alternative investments



John Burson     Subscribe
What Are Alternative Investments

CONTENTS

WHAT IS THE ALTERNATIVE WHY ALTS

Alternative investments, or ALTs, 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 alternative investments 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. However, 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 alt investments 3. Private equity involves an investment of capital in private companies that are not available for trade on the NYSE, NASDAQ, or any public exchange. The capital investment may be venture capital, growth capital, or buyouts.
  • Real Assets
    Tangible 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).

    Learn more about What is an Accredited Investor?

  • 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.

Why invest in alternative investments?

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.
    Alts investments have less exposure to the major markets, making them less sensitive to market volatility5.
  • Low market 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 market.

low correlations

  • Possible greater returns.
    Alts investments offer higher returns as compensation for taking higher risks. Alternative investments often have the potential to generate higher returns than traditional investments due to their unique risk-return profiles. For example, private equity investments may provide higher returns than publicly traded stocks due to their illiquidity and the ability of private equity firms to manage their portfolio companies actively.

What Are Alternative Investments

  • Hedges against inflation.
    Real estate, oil, and gold are alternative investments that are potential hedges against inflation. Alternative investments such as real estate, commodities, and infrastructure may offer inflation protection benefits due to their tangible assets and/or ability to generate cash flows that can increase with inflation.
  • Diversification.
    Since alternatives have a low correlation to stocks and bonds, you can improve diversification in your portfolio by adding an alternative asset solution. Alternative investments such as real estate, private equity, and hedge funds can benefit diversification by offering exposure to different asset classes and strategies than traditional investments like stocks and bonds. This diversification can help to reduce overall portfolio risk by spreading investments across different types of assets with low correlations to each other.
  • Access to unique investment opportunities.
    Alternative investments can provide access to investment opportunities that are not available through traditional investments. For example, investing in a start-up company through venture capital can provide exposure to innovative technologies and potentially high-growth companies that may not yet be publicly traded. It's worth noting that alternative investments typically have higher fees and require greater due diligence than traditional investments. Investors should consider their investment objectives, risk tolerance, and overall portfolio before investing in alternative investments.

What are Some Alternative Investment Drawbacks?

Like any asset class, alt 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 information available to investors. However, alt 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, investing through an investment firm specializing in alternative investment strategies backed by real estate, farmland, or commodities may be more advantageous. These firms generally have the expertise to properly study and evaluate the risk/return potential to provide an alternative investment portfolio solution or investment strategy.

FAQs

What are some examples of alternative investments?

Alternative investments offer individual and institutional investors viable opportunities for building wealth. The most popular alternative assets are

What is the best alternative investment?

Generally, 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.
  • However, 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 has 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.

Is private equity an alternative investment?

Yes, private equity is considered an alternative investment.
Private equity investments typically involve investing in a company to improve its operations and financial performance and ultimately increase its value. Private equity investments are often illiquid, meaning it can be challenging to sell or transfer ownership of the investment before its intended exit date. Private equity investments can also be riskier than traditional investments due to their concentration in a single company and lack of market liquidity.

Private equity investments can provide diversification benefits to an investor's portfolio by offering exposure to a different asset class than traditional investments. Private equity investments also have the potential to generate higher returns than traditional investments due to the ability of private equity firms to manage their portfolio companies and improve their financial performance actively.

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 

 
 
 

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