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Alternative Investments

Alternative Investments

An alternative investment is a financial asset that does not belong to any conventional investment categories, such as cash, stocks, and bonds. They are characterized by exceptional return potential, complexity, and the use of leverage products and derivative financial instruments.

What Are Alternative Investments?

It is an innovative investment product that is associated with less transparency and less liquidity. Nevertheless, alternative investments can optimize the return for a portfolio with a given risk structure. In addition, the risk can be reduced with the same return possibilities. They are an excellent tool for portfolio diversification and can significantly improve their risk-return ratio.

Unlike traditional investments, AIs are not regulated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, and their practices are subject to examination by the SEC. However, they are not obliged to register with the SEC and thus not regulated by this commission. Therefore, if you are thinking of alternative investments, you should conduct research of available AI offerings to avoid scam.

Alternative investments include hedge funds, private equity, real estate, infrastructure projects, futures, derivatives, and commodities. Sometimes even art, antiquities, and wine can be considered as AIs. AIs typically have a low correlation with standard asset classes, meaning that they often move counter or the opposite to the stock and bond markets. This feature makes them a suitable instrument for portfolio diversification. Additionally, investments in gold, oil, and property provide an effective hedge against inflation. Because of this, many large institutional funds such as pension funds often allocate a small portion of their portfolios to alternative investments.

Hedge Funds

These are actively managed investment funds that invest in traditional asset classes but use unconventional, divergent, and highly complex investment strategies to generate returns, such as:

  • leverage for investment and trading purposes,

  • short selling,

  • market inefficiencies,

  • price differences,

  • event-driven strategies,

  • macro analysis.

For example, hedge funds are speculating on falling stock markets by borrowing shares from index funds and later return them.

Private Equity

Private equity means that investors make OTC equity available. In contrast, to share capital, private equity cannot be offered and demanded on a regulated market such as the stock exchange because the companies are not publicly listed.

The equity lender often acquires shares in companies with a high level of leverage, such as bank loans, bond issues, or private equity funds. The goal is high dividends in the future or a considerable return through the later sale of the company share. The equity is brought in when the company is founded or is at the growth stage. In startups, private equity is referred to as venture capital because of its higher risk.

Real Estate

There are many forms of alternative real estate investments, such as closed funds and special real estate funds. In their turn, these funds invest in property or stocks of REITs (real estate investment trusts). REITs are corporations that generate profit from the leasing, lending, and sale of property and land. Alternative investments also include crowd investments for real estate, which allows property developers to get positive returns in the short term.

Alternative Investment Trends

Having significantly grown over the last decade, nowadays AIs attract mostly private investors. Thanks to crowd investing, investments in high-yield real estate no longer require large assets to participate in earnings directly. By collecting small amounts through a crowd investing platform, it is possible to jointly finance such properties. This not only allows private investors to avoid negative interest rates but also cleverly divides their money. They have diverse investments that are not related to the development of traditional financial assets. These can more effectively protect against high losses in times of crisis.

As securities no longer yield positive returns, investors need to take risks for greater profitability. In addition, equity investments are subject to high volatility and uncertainty about future price performance. Furthermore, the close interdependence of global markets means that the performance of classic financial investments is at times similar. This considerably impedes the optimal diversification of a portfolio.

In 2005, managed assets under alternative investments were $3.2 trillion worldwide. In 2013, this number has grown to $7.9 trillion. Experts predict that if this growth remains unchanged, around $15.3 trillion of managed assets will be invested in AIs in 2020. It means that about 14% of the total managed assets across the world will be invested in AIs.

Wrap-Up

AIs are the type of investments other than the traditional ones, such as stocks, bonds, and cash. Alternative investments include hedge funds, private equity, real estate, infrastructure projects, futures, derivatives, commodities, art, and antiquities. AIs are favorable for private investors, allowing them to diversify their portfolio. At the same time, they may be risky because of low liquidity and lack of regulation.