Financial assets, known as alternative investments, don’t fit into the same asset categories as traditional assets like cash, stocks, and bonds. While institutional investors and high-net-worth individuals mostly seek these assets, they’re still available to retail investors. However, traditional asset categories are still important to contemporary investors.
Keep reading to learn more about alternative investments.
Alternative Investment Types
- Real Estate
Real estate is one of the best investments anyone can make. It’s divided into residential and commercial real estate. But the residential real estate market is significantly bigger than the commercial market because it accounts for nearly 75% of the global market.
Investors buy property because real estate retains its value well over time. Like other economic assets, the real estate market is also subject to fluctuations. It’s subject to the forces of demand and supply.
Buying a property can be expensive. However, you can enter the real estate industry through alternative vehicles like Real Estate Investment Trusts (REITS) or crowdfunding. These are ideal if you’re low on cash since transaction costs are low.
- Hedge Funds
A hedge fund is an entity that pools the financial resources of multiple investors. They reinvest these funds to generate profits for investors. Hedge funds manage vast financial assets. Institutional investors, mutual funds, or high-net-worth individuals are usually the main investors.
Hedge fund managers are in charge of managing all of these assets and devising strategies for profiting from them. Some of the world’s most successful hedge funds are managed by some of the most financially savvy individuals. They are knowledgeable in areas such as volatility arbitrage and quantitative strategies.
- Natural Resources
Natural resources are assets that can be mined from the earth or farmed.
Even though the value of minerals like gold or silver is affected by several variables, their values are relatively stable because the supply of natural resources is limited. Non-renewable resources will eventually run out in the future. Their scarcity makes them all the more valuable.
However, much like other economic assets, values will fluctuate over time. But what’s certain is that in economic crises, you’re better off having precious metals (gold, silver, platinum, palladium) or precious stones (diamond, ruby, emerald) on hand because they are a great hedge against inflation.
You might ask, is gold more valuable than diamonds? Both resources are valuable in the market. However, they also have certain distinguishing characteristics which investors must consider before buying them. Each has its pros and cons. So you have to assess them to make an informed decision.
Precious metals like gold and silver are relatively more abundant, making them more accessible. That’s why it’s wise for any investor to add them to their portfolio. You can invest in them, whether it’s in physical form, mining stocks, or even exchange-traded funds (ETFs).
- Private Equity
Funds and investors investing in private enterprises fall under this broad investor group. Private equity investors typically finance startups. Institutional and non-institutional investors are often funding sources for private equity firms. They reinvest this money in private companies.
- Venture Capital (VC)
It’s a subset of private equity that concentrates on funding early-stage businesses. They invest in startups that are in the early or growth phase. Often, wealthy or high-net-worth individuals provide funding to venture capital firms.
Venture capital investing is risky. Most venture capital firms assume a management role in some startups they invest in to protect their interests. Nevertheless, you can profit if you invest in VC firms with competent management. Hence, you must pick the correct venture capital to invest in if you’re an investor.
- Private Debt
Private debt is funding that you don’t get from banks. This type of funding isn’t limited to private individuals. But even public entities can get money from private sources. Companies typically borrow money because they want to finance growth. Some go to private debt firms to secure the funding they need. Private debt companies usually make money through interest payments and loan repayments.
For those who enjoy collecting valuable items, you can make money from this type of investment. Collectible assets include classic paintings, watches, coins, cars, jewelry, and wine.
Many high-net-worth individuals nowadays are investing in classic timepieces. While one can buy an expensive watch because of its aesthetics, it’s also usually a good investment because most things appreciate over time. So the potential for making significant returns is high.
Infrastructure is an alternative asset class that governments have traditionally offered. But over the years, private investors have also gotten involved. It’s unsurprising to see private and public players partnering on infrastructure projects. One of the most profitable projects involves renewable energy solutions or projects to achieve the net-zero target.
Infrastructure investments can be placed into two categories based on development stages:
- Greenfield Investment – This term describes investments in infrastructure assets or projects yet to be constructed.
- Brownfield Investment – This term describes investments in existing infrastructure assets or projects.
Regardless of which category you wish to invest in, you must conduct ample research to assess the risk and return. There is a certain degree of risk associated with every project. But the chances of getting good returns are high if you pick the right investments.
Reasons To Consider Alternative Investments
Hedge Against Inflation: Investing in assets like gold, silver, and oil provides a hedge against inflation. That’s because these ‘hard assets’ generally preserve their value well over time.
When an economy enters a depression, for example, investors prefer holding onto assets like gold instead of cash or stocks because the value of gold has a low correlation to the stock market.
Even though the value of gold is subject to fluctuation, it generally holds its value well over time. That’s also the case with other precious metal investments like silver and platinum.
Low correlation: Low correlation means that alternative investment values typically move counter to the stock and bond markets. It’s what makes them the ideal diversification tool for any investment portfolio. For this reason, most investors ensure that their portfolios have at least 10% in alternative investments.
Diversification: Portfolio diversification is important because it enables investors to spread risk. Different asset classes have different risk profiles. Wise investors should design portfolios with different risk profiles so that if one investment tanks, other investments will perform well and offset the loss.
Potential Drawbacks Of Alternative Investments
Hard To Value: Since information isn’t always available, it’s hard to determine the value of some alternative investments. For example, if you’re selling a rare gold coin, you need to know and understand the history of its origins and the hands it passed through to gauge its market value. Even then, you may not be able to properly assign a value to it.
Harder To Manage: Investors don’t mind adding alternative investments to their portfolio due to fewer regulations, but it increases the chances of fraud and scams. Therefore, it’s incumbent on investors to carry out due diligence before investing in anything. You must conduct thorough research to ascertain whether an investment has sufficient returns to justify its risk profile.
Illiquidity: Compared to conventional investments, alternative investments are generally more illiquid. Take collectibles, for example. If you have a bottle of whisky that’s 100 years old, it won’t be easy to sell. Selling 5,000 shares of a reputable or valuable company on the stock market will be much easier. The roadblock with such an investment mainly lies in how difficult it is to assign value to such a rare commodity.
Alternative investments have become quite popular among investors in recent years. The main reason is that their low correlation makes them perfect for diversifying asset portfolios. Plus, some alternative investments like gold and silver are great inflation hedges. Given the current uncertain economic times, investors will and should add alternative investments to their portfolios to spread risk.