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What Are Alternative Investments?
If you have any experience in investing, or even if you have heard people talk about investing, you are probably familiar with the term "alternative investment." But what exactly does it mean? What are alternative investments, and how can they benefit your portfolio?
In the simplest terms, an alternative investment is a non-traditional financial asset, meaning it is not categorized with conventional assets like cash, stocks, and bonds. There are several types of alternative assets, including private equity, private debt, real estate, commodities, and more. If you choose to invest in wine with Vint, that will entail alternative investments.
Are you interested in diversifying your portfolio and positioning yourself for a higher potential return with lower risk? You've come to the right place. Keep reading to learn more about alternative investments and how they work.
A Deeper Look Into Alternative Investments
Most alternative assets are owned by high-net-worth individuals or institutional investors because of their degree of risk, lack of regulation, and general complexity. It is common for an alternative investment to require substantial upfront investment fees and high-initial minimums. That is especially the case compared to ETFs and mutual funds.
That said, these investments usually come with lower transaction costs because turnover is lower. Contrary to conventional investments, most alternative assets are relatively illiquid. Take, for instance, a 6-year-old bottle of fine wine and 500 shares of Alphabet. Because of the limited number of buyers, you might find it more challenging to sell the wine than you would the Alphabet shares.
Another thing to consider is that alternative assets are often rare, making it hard to put a specific value on them. For example, it is challenging to value a 90-year-old $20 gold coin because only a few exist.
What Is the Strategy for Alternative Investments?
There is usually a low correlation between alternative and conventional asset classes. As such, alternative investments often counter the activity of the stock and bond markets, which makes them ideal for diversifying your portfolio. What's more is that investing in wine, real property, gold, and other hard assets can protect your investment against inflation, which lowers the purchasing power of paper cash.
Private endowments, pension funds, and other significant institutional funds tend to put less than 10% of their portfolios toward alternative investments. That said, non-accredited retail investors can also add alternative assets to their portfolios.
These days, many people can invest through ETFs and alternative mutual funds. These funds are publicly traded, which means they are regulated and registered with the SEC and bound by the Investment Company Act of 1940.
What Are Common Types of Alternative Investments?
Conventional investments are only a part of the picture regarding investing. Alternatives are a highly dynamic asset class covering many different, unique investments. More and more alternative assets are becoming accessible to individual investors; therefore, all industry professionals and investors should learn about alternative investments.
While alternative assets can vary in structure and accessibility, they all share specific characteristics. The SEC does not regulate alternative investments, and they are illiquid. Also, alternatives barely correlate to standard asset classes, so they often don't move similarly to traditional assets when the market changes.
Other than these key traits, the alternative asset class is quite diverse. Let's talk about a few of the most common alternative investments and how each of them is unique:
Private Equity
A vast category, private equity, is making a capital investment into a private company, which means no public exchanges list the company. One subset of private equity is venture capital, which revolves around early-stage companies and startups. Growth capital focuses more on helping established businesses restructure or expand. And buyouts are a type of private equity that occurs when a business is purchased outright.
Private equity goes further than capital, and the relationship between investors and the company receiving funds is essential. Many private equity firms will provide mentorship, industry expertise, talent sourcing, and many other benefits in addition to capital.
Private Debt
Both private and public companies can use private debt for borrowing money. What sets private debt apart from other investments is that banks are not involved in the financing. Additionally, private debts are not traded on an open market.
Companies often use private debt to obtain additional capital for expansion and growth. Private debt funds are the companies that provide the money. These companies make a profit either through initial loan repayments or interest payments.
Real Estate
Real assets refer to timberland, farmland, commercial property, residential property, and many other types of investments. However, real estate is the most common and most significant asset class by far.
One interesting aspect of real estate is that owning a property means that you can receive immediate income from paying tenants along with equity as the long-term value of the property increases (called appreciation). If you invest in bonds, you likely see the similarities.
One challenge in real estate investments is valuation. If you want to succeed in real estate investment, you must develop excellent valuation skills and know which methods to use when. Valuation requires considering sales comparable, income capitalization, and discounted cash flow. Each of these presents benefits and drawbacks.
Commodities
Another type of real asset is commodities, typically natural resources like natural gas, precious metals, oil, and agricultural products. Because they are not reliant on public equity markets, investors use commodities to hedge against inflation. Supply and demand determine the value of commodities; the higher the need for the commodity you are invested in, the higher the prices and profit.
People have been investing in and trading commodities for thousands of years. The first formal commodities exchanges date back to the 16th and 17th centuries.
Collectibles
One of the most attractive alternative investments is collectibles, including fine wine, classical art, and vintage cars. Essentially, people invest in collectibles hoping that the value of their assets will appreciate. For example, you could invest in wine through a platform like Vint and hold your investment until the value increases over time.
Investing in collectibles can be a fun method for diversifying your portfolio, but it doesn't come without risks. Not only can your assets be destroyed if you don't care for them or store them appropriately, but they can also cost a lot of money to acquire. That said, as you learn more and more about the collectibles you are investing in, you can start to estimate the return you can expect on your investment.
Hedge Funds
Investors use hedge funds seeking to earn a high return. It involves trading liquid assets and using different investment strategies.
Many hedge fund managers specialize in various skills, including volatility arbitrage, quantitative strategy, long-short equity, etc. Only institutional investors like pension funds, mutual funds, private endowments, and high-net-worth individuals have access to these types of investments.
"Wining" Down
Alternative investments are becoming more and more popular in the investment world. Among other benefits, many types of alternative assets are available to non-accredited individuals and are not dependent on the state of conventional markets. However, to succeed, you must know the ins and outs of whatever assets you choose to invest in. That said, you will learn many things as you gain experience.
If you are interested in bringing diversity to your portfolio, consider investing in private equity, real estate, collectibles, or other alternative assets. To get a quick and simple start for your fine wine investments, choose a platform like Vint.
Sources:
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