Finance

Alternative Investments

Alternative Investments

Investing is owning an asset or item with the intention of generating some income or appreciation in the value of the asset. An investment is any means to generate an income in the future including bonds, stocks, real estate, etc. Alternative investments are unconventional investments or investments other than stocks, bonds, and cash. Generally, these types of investments are done by large institutions, high net worth individuals, etc due to their complexity, riskiness, and lack of regulation.

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Features of Alternative investments:

  • Less correlation to conventional investments: Alternative investments have a low correlation with conventional investments. Hence, this provides great advantages and opportunities for portfolio diversification.
  • Comparatively low liquidity: Compared to conventional investments, alternative investments have lower liquidity due to the non-centralized markets and lower demand for some assets.
  • Complicated valuation: It is hard to determine the underlying value of alternative investments. Its valuation requires specific knowledge and some exotic investments can also show unpredictable demand patterns.

Types of Alternative Investment:

  1. Private equity: Private equity makes capital investments into private companies or companies that aren’t listed on an exchange or private companies that buy out public entities and hence dissolve the public status. Their revenue is not dependent on market changes. An investor can invest in these companies and become a part-owner of the company. Hence, large returns can be made on smaller amounts of money.
  2. Hedge funds: Hedge funds are investment funds that trade comparatively liquid assets and use different investment strategies to earn a high return on their investment. They help protect investors from market volatility and downturns better than other investment benchmarks. Investing in hedge funds also helps the investor diversify their portfolio.
  3. Venture capital: Venture capital funds or provides capital for ideas and startups. They are like private equity but they mainly focus on startup and early-stage ventures. In venture capital, funds are devoted to obtaining absolute returns, without being concerned or affected by the ups and downs of the open markets.
  4. Real estate: Investors make money by investing in real estate through rental income, appreciation,  and profits depending upon the business in which the real estate operates. Passive income, stable cash flow, diversification, tax advantages, and leverage are some perks of investing in real estate.
  5. Collectibles like wine, art: Collectibles like wine, art, rare watches, artifacts, etc are historic investments and appreciate in value much faster than regular investments. One of the evident advantages of investing in collectibles is that they’re tangible. So you can physically marvel at the intricacy of the movement of your rare watches. However, collectibles are less liquid than traditional securities.

How are alternative investments different than investing in the stock market?

  • Compared to traditional investments, alternative investments are more illiquid. They are also more difficult to value.
  • Alternative investments are riskier than conventional investments. But where there is high risk there are high returns too.
  • Alternative investments have a low correlation with conventional investments and so they tend to counter stock and bond markets. This helps in portfolio diversification.
  • Except for precious items like coins or art, alternative investments are largely unregulated and are prone to fraud and scams.

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Conclusion

Alternative investments are investments in precious items, hedge funds, fine art, etc. They are more suited for high net worth individuals and large institutions due to their risky and complex nature. They are less regulated than traditional investments. They often counter regular investments and hence are a great tool for portfolio diversification.

Author – Abha Shetty

About the author – Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

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