Alternative investments go beyond traditional cash, bond, and stocks. They belong to a very dynamic asset class that covers a variety of investments with peculiar characteristics. Many of these investments are becoming more accessible to retail and individual investors. Hence, it is critical to understand the basics of alternative investments if you want to make sound investment decisions in your life.
Even though alternative investments can be very profitable, there are a couple of things you must understand about them:
- Alternative investments such as cryptocurrencies are sometimes unregulated, which means stricter due diligence is essential.
- Some of these assets, such as property, art, etc., may not be liquid because you cannot quickly sell or convert them into cash.
- They slightly correlate to standard asset classes; they don’t always move in the same direction as other assets when subject to market fluctuations.
What are some popular alternative investments?
Here, we have enlisted some popular types of alternative investments that every investor must know.
Private debt is financed by entities aside from banks. Besides, they are also not traded in an open market.
Private debt funds raise money from investors before lending it to public and private companies. Investors make money either through interest payments or the initial loan repayment.
Hedge funds are the alternative investment funds that trade relatively liquid assets to earn a high return. However, hedge funds are exclusively available to institutional investors, such as mutual funds, pension funds, and high net-worth individuals.
To maximize the return on investments, hedge fund managers often specialize in various skills to design and execute multiple investing strategies, such as long-short equity and volatility arbitrage.
The world of tangible assets extends to land, timberland, farmland, and even intellectual property like artwork. However, real estate is the world’s most important asset class.
Real estate investments are considered similar to bonds in that property owners receive current cash flow through rental income and equity.
Commodities are primarily natural resources and fall under the category of tangible assets. When you invest in commodities, you invest in resources like oil, natural gas, precious metals, industrial metals, and agricultural products. These assets are typically illiquid. However, if one wants to invest in commodities but also wants liquidity, one can also invest in Exchange Trade Funds (ETFs) representing the various commodities.
Since commodities are less affected by public equity markets, they are considered a hedge against inflation. The value of commodities rises and falls depending on their supply and demand in the market.
The higher the demand, the higher profits investors earn.
Structured products are a part of fixed income markets as they pay investors dividend payments just like corporate or government bonds do. They can be complex, challenging to comprehend, and sometimes very risky. However, they act as a customized product mix that suits the needs of individual investors.
Examples of structured products include credit default swap (CDS), collateralized debt obligations (CDO), and mortgage-backed securities (MBS).
Collectibles are alternative investments that involve various items ranging from rare wines to vintage cars. When you purchase such things, you also need to maintain them, hoping that their value will appreciate with a considerable margin over time.
Though these investments sound more exciting and fun, the risk is higher due to the high cost of acquisition, lack of income until they are sold, and possible damage to the items if they aren’t cared for properly.