If you are an investor and you just want to see what the opportunity is pop down to the last paragraph:
Alternative investments provide an interesting opportunity for investors to diversify their portfolios, dampen the impact of market volatility and help them achieve their long-term investment objectives, even during times of market uncertainty.
Along with these potential benefits come additional complexities and risks. This is why it is imperative that investors understand the various strategies available to make more-informed decisions regarding the role of alternatives in their portfolios.
The definition of alternative investments
With traditional investments forecasted to deliver ‘boring’ returns of approximately 4% per year over the next 10 years, both institutional and individual investors are always looking to alternative investments to try to meet their diversification and return objectives.
But what are alternatives? Simply put, they are any investment that falls beyond traditional long-only investments, such as stock and bonds. Because alternatives tend to have lower correlations to traditional investments, they are primarily used to diversify an investment portfolio and provide return profiles that may differ from those of traditional investments.
For larger institutional investors with a tolerance for illiquidity, alternative investments could include a good mix of hedge funds, private equity, alternative credit, and real estate. For individual investors, the alternative investment universe may include all of these and even vintage cars, rare wines, or fine art.
With such a broad range of investments in the category, it’s important to fully understand the unique risks and benefits of alternatives before incorporating them into a portfolio.
The key characteristics of alternative investments
Alternative investments cover a wide range of assets and strategies. Generally speaking, however, they are characterized by:
- Low correlation to traditional investments like stocks and bonds
- Typically higher return potential than traditional investments
- More esoteric and oftentimes illiquid assets
- Longer lock-up of periods, meaning shares or interests may not be able to be redeemed/sold on a daily basis. This helps allow for exposure to less liquid assets
- Often complex investment structures and risk-return profiles
- Typically, higher minimum investment requirements
- Unique risk profile that should be understood prior to investing
The types of investors who may be suited to alternative investments
Alternatives are not suitable for every investor. Given their unique risk-return profile and complex investment characteristics, these products are often most attractive and more suitable for more sophisticated and higher-net-worth investors.
In addition to meeting minimum investment and suitability requirements, investors should also consider their time time scales, investment objectives and their ability to withstand periods of volatility before considering an allocation to alternatives.
Some attractive alternative investment strategies
Alternative investments have grown in popularity over time. Today, alternatives include a spectrum of strategies, each designed to support a unique objective and with a different risk-return profile. Below are some of the most common.
Alternative Credit
Alternative credit investments refers to illiquid financing provided to borrowers that cannot access public credit markets or require non-standard, customized terms. Categories of lending within alternative credit include direct lending, mezzanine, distressed debt, and specialty financing.
Private Equity
Private equity investments (typically accessed through a limited partnership) take an ownership position in businesses and companies or securities that typically are not listed on a public stock exchange. Themn aim is to add value by providing capital to help new businesses expand and by restructuring existing businesses with operational inefficiencies that offer the potential to generate significant long-term gains.
Venture Capital
By swapping capital for an equity ownership stake, venture capital investors provide funding to early-stage start-ups they expect to grow substantially. The goal is to guide the firm with the intent of selling it either through acquisition or an initial public offering.
Real Estate
Real estate has evolved into a multi-faceted asset class that includes publicly-listed and private real estate investment trusts (REITs) and private commercial real estate debt. Real estate not only has a low correlation with equities, but is often viewed as a hedge against inflation.
Hedge Funds
Hedge funds are investment vehicles that use a range of non-traditional strategies (e.g., pairs trading and long-short strategies) in an effort to maximize the overall return potential and diversification of a portfolio. Some of these non-traditional strategies
Alternative investments and hedge funds involve a high degree of risk and can be illiquid due to restrictions on transfer and lack of a secondary trading market. They can be highly leveraged, speculative and volatile, and an investor could lose all or a substantial amount of an investment. Alternative investments may lack transparency as to share price, valuation and portfolio holdings.
Complex tax structures often result in lethargic tax reporting. Compared to mutual funds, private funds are subject to less regulation and often charge higher fees. Alternative investment managers typically exercise broad investment discretion and may apply similar strategies across multiple investment vehicles, resulting in less diversification. Trading may occur outside the United States which may pose greater risks than trading on U.S. exchanges and in U.S. markets. Diversification does not ensure against loss.
One such investment opportunity dropped on my desk this week with a Triple A rated Asset backed security and I would certainly meet with these guys and see what it is all about.
It is a UK registered based investment
Minimum investment is US$50,000 and then in multiples of US$25,000
6 monthly term. At end of six month can be rolled over into a new investment
Interest rate is 4% per month. Payable at end of first 3 months (so 12%) and then monthly.
This equates to 24% for 6 months, 48% for 12 months and hence 96% for two years. Effectively doubling your money every 2 years
Investment is not subject to stock market movements so hence is a fixed term deposit
Investment monies are not invested at all but used to support a line of credit in which the line of credit is invested.
There is no lien or security placed over the investment. To further support this there is an insurance bond put on the investment which is from Ginnie Mai – the US Government National Mortgage
Association. This Association is supported by the US Federal Reserve.
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