What Are Alternative Investments? Definition and Examples

For many years, “stocks, bonds, and cash” constituted the fundamental trinity of investment portfolios. For wise investors seeking to diversify and possibly increase returns, a new realm of “alternative investments” offers bright futures.

By the end of this article, you’re going to know exactly “what are alternative investments” and a variety of typical “examples of alternative investments”, and you’ll learn why they’re taking the system over by storm and, with that, the key benefits as well as risks that come with them.

With a little education in alternative investments, you can broaden your investment horizon and build a stronger investment portfolio.

1. What Are Alternative Investments? Definition and Examples

How Are Digital Assets Different From Traditional Assets?

“Alternative investments” are financial assets that do not fit into traditional investment categories, such as publicly traded stocks, investment-grade bonds and cash. They are generally less liquid, may be less transparent and may currently be subject to less oversight than other asset types.

Objective: They are regularly requested to:

• Diversify Portfolios: Because of their low correlation with traditional asset classes.
• Possibly Produce Higher Returns: Typically with Higher Risk.
• Hedge Against Inflation: Some kinds, such as real assets.
• Access Exclusive Opportunities: Restricted markets or industries.

Key Characteristics:

• Illiquid: Not readily purchasable or saleable on public exchanges.
• Larger Minimum Investments: Usually limited to ‘accredited investors’ clients or High Net Worth Individuals (HNIs), but access is being opened up.
• Less Regulation: A catalyst for less transparency.
• Complexity: May require specialized knowledge.

2. A Broad Array of ‘Alternative’ Investments

A Glimpse into the World of Non-Conventional Assets

1. Real Estate (Beyond Public REITs): Owning the real estate directly (apartment building, commercial building, land) for rent or appreciation. This could be through fractional ownership in a commercial property or via a project.

• Example: Include investing in a commercial complex, leasing out an apartment, and using a real estate crowdfunding platform for a particular project.
• Note: Although REITs are similar, direct or private real estate funds are considered alternatives as a result of their illiquidity and direct management.

2. Private Equity (PE) & Venture Capital (VC): Investing in companies that are not listed on the stock exchange.

• Private Equity: Usually invests in seasoned private companies, mostly for buyouts or growth capital.
• Venture Capital: Focuses on young, high-growth companies that have a high potential.
• Examples: Putting money into a fund that buys private businesses or funding a hot new tech startup in Bengaluru.

3. Hedge Funds: Investment funds that are open to a limited number of accredited investors and that engage in a wider range of investment and trading activities than most funds, which include long/short equity, global macro strategies, and arbitrage, among others. Hedge funds also typically use leverage and may use derivatives.

• Examples: An investment in a fund that employs sophisticated trading strategies throughout multiple classes of assets. For more on hedge funds, see Corporate Finance Institute’s explanation.

4. Commodities: Base goods or raw products, as they are found in their natural state, such as gold or cattle.

• Examples: gold, silver, crude oil, natural gas, agricultural products (wheat, corn). Physical/Futures/ETF Physical or futures/ETF way to invest.

5. Private Debt/Private Credit: Providing capital directly to private companies, typically those which are unable to borrow from banks or public credit markets. This lending can be structured as direct lending, mezzanine debt, or well as distressed debt.

• Examples: Investing in a fund that lends to expanding businesses.

6. Collectibles & Physical Assets: Tangible and finite products that derive value from their rarity, age or beauty.

• Examples: fine art, rare wines and classic cars, in addition to rare coins, stamps, antiques and luxury watches.

7. Infrastructure: Spending on big public works or critical services.

• Examples: Roads, bridges, airports, power plants, and communications networks, frequently through specialized infrastructure investment funds.

8. Farms: Direct investments in 100%-owned agricultural operations or leased land to farmers or pure speculation.

• Examples: Buying up agricultural land for lease or investing in a farmland investment fund.

3. Why Consider Alternative Investments? (The Benefits)

The Advantages of Going Beyond the Norm

• Diversification: reduced overall portfolio risk and volatility is possible with low correlation with the traditional stock and bond markets, particularly during market downturns.
• The potential for higher returns: A lot of alternatives, especially in the world of private markets, promise the potential for higher risk-adjusted returns relative to traditional assets.
• Hedge Against Inflation: Physical assets, such as real estate and commodities, tend to retain or increase their value in an inflationary environment.
• Unique Access to Opportunities: invest in new companies or niche markets not offered on public markets.
• Lower Market Volatility (Sometimes): Because of the illiquidity, their values do not swing daily like public stocks would, providing a less bumpy ride (though the underlying value can still change).
• Professional Management: A good number of alternative funds are run by professionals in those respective markets.

4. The Risks Associated with Alternative Investments

Understanding the Downsides Before Investing

• Illiquid: Not easily or quickly sold at a price close to fair value. Funds often have lock-up periods.
• Complexity & Opacity: Difficult to understand and less regulated, so less information is publicly available.
• High Minimum Investments & Fees: It is usually only available to wealthy investors, and fees can be higher with fund managers charging extra in management and performance fees.
• Valuation issues: Not easy to value with precision because they do not trade on any public exchange.
• High Risk: Can lose a substantial amount of your investment strategies, particularly with venture capital or speculative investments.
• Less Regulation: Provides less oversight than with other publicly traded traditional securities.
• Manager dependence: Performance may be highly dependent on the manager’s skill and judgement.

Conclusion

In short, “alternative investments” comprise a variety of asset classes that are not traditional stocks, bonds, or cash, which provide unique “benefits” such as diversification and potential for higher returns, which are offset by real “risks” such as illiquidity and complexity.

Despite the potential to add value to a portfolio, not every investor is right for alt investments. And like anything else, what’s most important is that you understand what they are, who they’re for, the pros of “examples, ” cons, and determine whether or not they fit into your portfolio. Seeking advice from an experienced adviser is a must before delving into such complex channels.

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No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor.

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