Alternative asset investments often provide a unique opportunity for portfolio diversification. These investments also minimize the effects of market volatility to ensure long-term returns even when the markets are uncertain.
Traditional investment classes will deliver about 4% in returns over the next decade. As such, individual and institutional investors are diving into alternatives to realize diversification and return objectives.
However, with their unique benefits and opportunities comes a good share of intrinsic risks and complexities. That’s why it is prudent for any investor to deeply understand the best alternative investments before including them in a portfolio.
What Are Alternative Investments?
Alternatives are financial assets that don’t fall into any traditional investment categories. Typically, the traditional categories include bonds, stock, and cash.
Since these investments have a lower correlation with traditional investments, they are often used to diversify an investment portfolio to ensure a return profile that differs from what you get from traditional categories. In essence, the market performance of alternatives is independent of the traditional market.
Unlike conventional investments, alternative non-conventional investments are illiquid –meaning you can’t convert them to cash quickly. For large investors with a high tolerance for illiquidity, examples of alternative investments often include a combination of private equity, hedge funds, real estate, and alternative credit. But individual investors may include additional investments like rare wines, vintage cars, and fine art.
Most importantly, alternatives have limited data that may not be readily available to the general public, and they have peculiar legal and tax considerations.
Investing Strategies for Alternative Investments
Alternative asset investments have a significantly low correlation with investment vehicles in standard asset classes. This means unconventional investments often move counter to bond and stock markets, making them suitable for portfolio diversification.
Investing in hard assets like oil, gold, and property can offset the effects of inflation which lowers the value of paper money. Due to this characteristic, most institutional funds often dedicate a portion of their portfolio to the best alternative investments.
Similarly, non-accredited retail investors can access global alternative investments. Specifically, you can access alternative mutual funds and exchange-traded funds. The alternative funds can give you an excellent opportunity to get into alternative asset category investments, which were previously cumbersome and expensive for average individuals.
Regulation of Non-conventional Investments
The investments lack strict regulations making them prone to scams and fraud even when they don’t involve items like fine art and rare coins. Unlike traditional investment classes, alternatives are subject to less clear legal structures. Typically, they fall under the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the Securities and Exchange Commission examines their deployment and practices. Nevertheless, it’s not mandatory to register with the SEC, meaning they are unregulated or overseen by the SEC.
As such, it’s crucial for aspiring and experienced investors to perform exhaustive due diligence before considering the investments. Only accredited investors with sufficient experience can invest in alternative investments in some specific cases. Legally, accredited investors are individuals or companies with a net worth of more than $1 million or at least $200,000 in annual income. Additionally, you can qualify for restricted investments if you are a financial professional with a FINRA license.
Common Types of Investments in Alternative Class
Alternatives have become wildly popular over the recent years, and investors have various options. Each alternative investments example has a distinctive risk-return profile.
- Alternative credit: It involves illiquid financing offered to borrowers with little to no access to conventional public credit facilities or requires custom credit terms. The categories in this type of investment may include distress debt, direct lending, and specialty financing.
- Private equity: These are provided through private partnerships, where the investor takes equity in a company that is not publicly traded. The primary objective is to offer the capital necessary to spark business growth. Also, some investors use this opportunity to restructure a business with operational inefficiencies to ensure the enterprise generates sustainable growth and profits.
- Venture capital: The investor funds early-stage startups with substantial growth prospects in exchange for an equity stake in the business. Here, the primary goal is to provide operational and strategic guidance to the company with the aim of selling the business through acquisition or IPO.
- Real estate: Unlike in the past, modern real estate has evolved into a diverse, multifaceted asset class. It may include private commercial real estate debts and public or private real estate trusts (REITs). Real estate investments have a significantly low correlation with conventional equities, but it’s an attractive hedge against inflation.
Alternative asset investments fall under a special category, and they can help you diversify your portfolio. And due to their low correlation with conventional investment classes, they can be the perfect tool for reducing investment risks. The unconventional investments often outperform traditional ones, thus offering better returns even when the market performance is dismal.