Why You Should Consider Alternative Investments
Your pick of investment opportunities isn’t restricted to the conventional world of cash and cash equivalents, stocks or bonds.
Investors have a host of other exciting and increasingly popular options known as alternative investments.
In the aftermath of the financial crisis that hit the global market over a decade ago, investors have been looking for different and reliable streams of income.
Alternative investments are financial assets that include, among others the following:
- Hedge Funds
- Private Equity
- Real Assets
These are some of the most common investment strategies for investors or portfolio managers who want to branch out from traditional methods and diversify their portfolios.
Unfortunately, some investors exhibit a certain degree of doubt when looking at alternative investments. There is a misguided belief that alternative investments are high-risk financial instruments reserved for large institutions and wealthy investors. The fact of the matter is that alternative investments are available to nearly every portfolio.
Therefore, let’s take a more detailed look at the various alternative investments that can produce considerable returns.
A popular alternative investment, hedge funds are investments funds that use capital from different investors and invest in various strategies and asset types.
Hedge funds rely on strategies that identify inefficiencies in the market, which gives them the opportunity to generate considerable value over a period.
However, you need to be mindful of restrictions on the type of investors who can contribute to a hedge fund. In principle, retail investors have difficulties gaining access to high-quality hedge funds, since there are high minimum investment requirements. For example, some hedge funds might require a minimum of $100,000 to take part.
A lot of private companies wish to attract investor capital. This is where private equity comes into play. Private equity companies use funds from both institutional and retail investors to invest businesses that have growth potential.
The invested funds can go toward innovation, acquisitions, and bolster working capital or the balance sheet.
Investors get their money back during an acquisition or an initial public offering. Private equity is a blanket term that refers to start-up investments and venture capital.
One of the most significant differences between private equity and hedge funds is that the latter enjoy better liquidity, which means that investors can pull their funds more easily and frequently.
Private equity gives businesses access to liquidity without high-interest bank loans. Many companies that aren’t listed prefer private equity financing because they aren’t typically subjected to the demands of quarterly reports that make it difficult for the company to find new ways to run more efficiently.
Finally, private equity investments allow investors a wide range or opportunities by covering a business’s lifespan.
Private equity comes with certain drawbacks. Firstly, the value of a company’s shares isn’t determined by the market, but is instead the result of a negotiation process between the buyer and the seller. This is also the case with shareholders’ rights, which are decided on individual basis through negotiation instead of broad governance framework.
Lastly, liquidating holdings in private equity tends to be a challenge because the company has to find a buyer in order to sell an investment or the entire business. Therefore, investors can’t rely on an order book that connects buyers with sellers as is the case in public markets.
This is a broad term that refers to all the different physical assets that have inherent value. The following are some of the most popular types of real assets:
- Real Estate
- Luxury and Collectable Goods
Real assets are non- financial assets. Financial assets receive value from other assets, whereas real assets derive value from their own qualities.
Let’s take a closer look at the most popular types of real assets which provide attractive investing opportunities.
As the most well-known alternative investment, real estate is a robust strategy for portfolio diversification since it isn’t strongly correlated to cash, stock or bond returns over a long time period.
Real estate investments offer investors instant cash flow and the possibility of capital gains. While direct investment into physical real estate is always an option, a real estate investment trust (REIT) is accepted as the preferred method of investing in real estate. An REIT can be an associate, corporation or trust that oversees a real estate portfolio consisting of properties and mortgages.
There are several important reasons to choose REITs over direct investment:
- REITs can be bought and sold on stock exchanges. Since REIT shares are traded daily, they provide better liquidity than investments in real estate property.
- Investors can buy REIT shares at a lower cost, while direct investment in physical real estate can require significant monetary commitment.
- REITs can provide investment opportunities in high-profile real estate, like first-rate shopping malls which are inaccessible to most investors. Owning shares in REITs that have invested in premium properties is one of the best ways to get obtain a stake in exclusive real estate assets.
- It’s impossible to achieve the desired level of portfolio diversification by investing directly in physical real estate because of high costs attached to a single piece of real estate. REITs provide investment opportunities across different forms of property and location.
- Investors don’t need to have any degree of expertise in real estate if they go through REITs. REITs rely on professional management which gets the most value from the properties by controlling expenses and increasing occupancy rates.
While REITs are unable to guarantee profits, they are famed for generating favorable returns. They manage risk by investing in a wide array of real estate holdings, making them a great diversified investment.
Commodities are physical assets that play a vital role in the global economy, which is why they are an important popular investment strategy.
Investing in commodities is based on taking a bet as to whether the price of a particular commodity will increase or decrease within a certain time period.
Commodities are classified according to their characteristics into the following sectors:
- Energy: Oil and Refined Petroleum Products
- Metals: Aluminum, Copper, Iron, Nickel, Zinc, Tin, and Lead
- Grains: Wheat, Corn, Rice and Soybeans
- Livestock: Cattle, Hogs, Poultry, and Sheep
- Precious Metals: Gold, Silver, Platinum
For investors looking to store their cash during volatile stock markets, commodities typically provided a safe haven since they move in counter direction to stocks.
In the past, commodity investors needed to have expertise and the willingness to dedicate time and money to invest in commodity trading. Today, investors interested in the commodities market have a number of ways to allocate their funds to the market without being experienced traders.
The commodities market is driven by basic supply and demand dynamics: lower supply pushes up the prices, while higher supply tends to pull prices down. Significant disruptions in the supply chain, such as a fatal accident in the world’s largest copper mine can have dramatic repercussion on the price of copper.
One of the most common ways to invest in commodities is with a futures contract, which is an agreement to purchase or sell a particular amount of commodity at a price at a set date in the future.
Some investors choose to use a commodity pool operator (CPO) to invest in commodities. A CPO is can either be an individual or a partnership that pools money from various investors and invests in future contracts. CPOs are required to provide account statements and yearly financial reports, as well as a detailed report of investors and transactions.
Exchange Traded Funds (ETF) let investors participate in the commodities market without actually investing in futures. ETFs follow the changes in prices of a specific commodity or a group of commodities that form an index. ETFs trade like stocks, meaning that investors don’t have to worry about management fees.
Commodities are a powerful diversification tool because typically have low correlations with the returns of conventional asset classes. As a result, if the prices of bonds fall, commodity prices will increase.
Commodities react differently to inflation than other financial assets. While the value of stocks or bonds decreases with inflation, commodities are able to withstand the pressure and maintain their value.
Investors in commodity futures can easily buy and sell contracts, providing them with liquidity whenever they need it.
Luxury and Collectable Goods
It should come as no surprise that investors looking for alternative investment opportunities turn toward the art world. One of the main reasons is art’s resiliency to economic volatility and interest rates. In other words, art is a great store of value. Not to mention that art is easy to feel passionate about investing in art!
However, bear in mind that art may be difficult to sell and can cost money to be kept safely.
According to a report compiled by Artprice, since 2000/2001, the global growth of the artwork market has grown over 1,700%. Also, investors in artwork benefit from over 8% annual yield.
Deloitte published a report in 2017 which claimed that the total investment in art in the United States is set to reach $2.7 trillion by 2026.
One of the disadvantages of investing in art is the required level of expertise. Most investors don’t know enough to choose which artworks will increase in value and when. This is why art investment funds play an important role for investors because they are designed to generate a considerable return through the acquisition and sale of different artworks. They are run by experts in the field and charge a management fee and receive a portion of returns.
Some art investment funds specialize in specific time periods.
While art is not the first thing to come into mind when thinking about alternative investments, it is nevertheless one of the most consistent and profitable investments in the
The Bottom Line
While investors in alternatives need to be patient, since most alternative investments don’t enjoy the same level of liquidity intrinsic to conventional asset types, they come with incredible benefits to investors.
Alternative investments provide a great diversification potential, which is one of the chief reasons investors allocate funds to this type of asset. A diverse portfolio of alternatives can strengthen its risk profile.
Also, alternatives have a tendency to generate higher returns than conventional assets when interest rates are low.
A number of alternative investments are strongly correlated to inflation, which makes them a desirable asset during inflation.
Therefore, alternative investments offer more benefits than may seem obvious at first glance: they are not correlated to the stock market, have the potential to provide higher yields than conventional assets, and are a strong barrier against volatility.