Alternative Investments: that will be the topic of today’s article.
Alternative investments offer diversification opportunities, essential for objective financial insights.
This article will discuss what alternative investments are, and the positives and negatives.
This content isn’t financial, legal, tax or any other kind of individual advice, nor a solicitation to invest. If you have any questions or want to invest as an expat or high-net-worth individual, you can email me (advice@adamfayed.com) or use WhatsApp (+44-7393-450-837).
You can continue on Part 2.
What are alternative investments?
To make it extremely simple to understand, mainstream investments include stocks, bonds, and cash. Such investments are usually held for a long term while expecting greater returns that are stable at the same time.
On the other hand, alternative investments are different from mainstream assets. Such alternative investments can be tangible assets like real estate, art, wine, precious metals, etc. At the same time, they are also available in the form of financial instruments such as private equity investments and hedge funds.
Why should you invest in such alternative investments? what are the benefits?
One of the greatest benefits of alternative investments is that of low correlation with mainstream assets. This means, for instance, when the stock market is not doing good, commodities might be performing well. Because of the correlation, investors can get access to a portfolio that is well-diversified.
Not just the diversification, but the volatility is low as the impact on the broader markets does not have an effect on these.
In most cases, the returns on alternative investments, compared to traditional investments, are usually higher.
Remember that if it’s too good to be true, it probably is, and the same applies to alternative investments as well. One of the major risks of investing in such assets would generally involve a higher level of risk.
Even though there are various options available as alternative investment assets, not all of them are regulated. Even the details related to such investment assets are not transparent because of the low regulations.
These assets aren’t usually traded publicly, and therefore, they lack liquidity that is offered through most types of asset classes.
The valuation of such assets cannot be done easily as there is no specific market price, and the actual valuation mostly depends on the appraiser.
These investment assets are not deemed apt for the general public as they are tailored for institutional clients. Especially, those who can deal with issues such as high risk and higher investment minimum.
Today, we will be discussing some common types of alternative investments along with their pros and cons.
At the end of this post, I will also list some alternative investments that can be a great addition to your portfolio.
Types of alternative investments
Real Estate
Investing in real assets is a common practice among people who invest in alternative investments. There are a lot of advantages of investing in real estate, and more than one method of investing.
Real estate is one of the leading investment assets, which is particularly accessible by retail investors as well.
I’ve covered all the aspects related to real estate investments in another article.
Raw Land
Owning raw land can offer different investment opportunities such as being able to sell it or build something on it. Building something means you can build a house or some other structure that can let for renting or used for personal purposes.
If you have raw land, which is set to increase in value over the future, then it can be one of the investment assets you can consider holding.
Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts (REITs) are entities that own and handle real estate while generating income.
This generated income is provided to those who invest in these REITs, yet however, investors do not own underlying assets.
Not only you will get payouts from what you invested in REITs, but you will also be able to access long-term profits and value appreciation.
Real Estate Investment Groups (REIGs)
These companies put the majority of their capital into real estate properties such as commercial multifamily properties.
In most cases, the real estate investment activity is carried out by investment partners, and the business income reporting activity is handled by the group.
Crowdfunding platforms
Real estate crowdfunding makes use of online resources to connect investors to real estate investments.
In simple words, it is just like owning a share when you invest in a company, but instead, you become a shareholder of the property.
With the help of crowdfunding, companies can raise capital that they might find hard to raise in general.
Residential Real Estate
There are multiple options available for those who want to get involved with residential real estate. By investing in residential real estate, you will be able to get returns in a multitude of ways.
Some methods include, flipping (buying, repairing/renovating, and selling), renting, and hosting guests through online sources like Airbnb.
The most common types of making money through investing in residential property investments include:
— Single-family homes
— Holiday rentals
— Multifamily units
— Flipping
— House hacking
— Hotels
— Serviced accommodation
Commercial Real Estate
Instead of offering a property to tenants, commercial real estate properties are rented or leased by businesses.
In general, these properties are usually leased for 12 months or longer, and the business leasing the property pays directly to the investor.
Some common examples of commercial real estate properties have been listed below.
— Retail spaces
— Healthcare facilities
— Offices
— Industrial properties
— Mixed-use spaces
Some businesses also lease commercial real estate properties for industrial purposes such as utilizing them as warehouses.
Pros and Cons of investing in Real Estate
- Pros
— No correlation between mainstream assets and their relevant markets.
— Diversification of portfolio, with likely chances of getting higher profits.
— Possibility of passive income, which means no necessity of handling the assets on your own.
— Rental income is considered much more predictable and safer for some, compared to dividend income from stocks.
— Capital appreciation over the long term, especially in places where the economic growth is more.
— One of the major types of investments that’s most likely to beat inflation, if invested properly.
— Investing in real estate with the help of a home loan comes with tax benefits, however, with some downsides.
— Expensive properties usually appreciate faster which may be beneficial when opting for leverage.
- Cons
— First of all, not every investor may be able to access an investment opportunity, especially because of the higher minimum capital requirement.
— Not just the buying process, but the effective handling of a real estate property also requires a lot of money and effort.
— The market may not be as liquid as one might think as it may take a lot of time to buy or sell a real estate asset.
— Capital gains tax is applicable in many countries.
— Passive investments may not need handling, yet you must consider the fact that you will not have ownership of the underlying asset.
— Finding suitable tenants may become hard, especially in tough economic situations such as what we are facing now.
— When the market situation goes south, it is possible for a real estate asset to fall in price. Take the housing bubble in 2008 for example.
Henceforth, it is suggested that real estate investments may not be a lucrative investment opportunity for everyone. Anyhow, it is worth adding to your investment portfolio, if and only if, you have the necessary capital at your hand.
Precious Metals
One of the great things about investing in precious metals is that they offer a great means of hedging inflation.
You will be still holding the underlying asset if you have purchased the asset, and the asset will appreciate.
Gold is the most common investment that pops into our minds when talking about precious metals. However, it isn’t the only one out there because there are others such as Silver, Platinum, Palladium, etc.
The increase or decrease in the value of precious metals is based on the factors such as demand, supply, geographical scenarios, etc.
If you have thought that buying precious metals is the only way of investing in them, then you might have to think again.
Investing in precious metals is also possible through the derivatives market, metal-specific funds and ETFs, mining company stocks, etc.
Investing in commodity-specific ETFs, stocks, and mutual funds is a good way when investing passively. Investing through derivatives like futures and options, or bullion may not seem that efficient.
On the other hand, certificates also offer the same features as physical ownership of gold, yet not having the ownership of underlying assets makes it extremely illiquid in times of emergency.
Pros and cons of investing in precious metals
- Pros
— Precious metals offer inflationary protection because they have intrinsic value and carry no credit risk.
— This means you can’t print more of them, which would generally see an increase in the demand, and appreciation of the capital.
— They can also offer insurance against financial or political/military disruptions, which affect most asset classes.
— Considering them from an investment point of view, precious metals offer a low or negative correlation to mainstream asset classes like stocks and bonds.
— This means a fraction of investments in precious metals in a portfolio will diversify the portfolio and reduce both volatility and risk.
- Cons
— Prices of precious metals can sometimes drop because of an imbalance between sellers and buyers. This is when there are more sellers than buyers, which decreases the supply and results in a price drop.
However, holding them for a long term may mostly be beneficial, yet, if you are involved with the bullion market, futures, or options, this may be risky.
— Geopolitical issues may also result in the price fluctuations of such precious metals, which has happened before.
Finally, investing in precious metals is a great option for diversifying your portfolio. ETFs, stocks, and mutual funds are somewhat good, but futures, options, and bullion may not be a great choice.
Hedge Funds
Hedge funds are actively managed investments that opt for risky investment strategies.
To get involved in a hedge fund, one must be able to put up a high minimum investment amount or have a significant net worth. Not just that, but they also require an individual to lock in their investment for a longer term compared to general assets.
The fees involved with hedge funds are usually higher compared to those of normal investment funds such as mutual funds and ETFs.
The strategies are dependent on the fund manager and may involve equity-based, fixed income-related, and event-based objectives. For instance, a hedge fund may concentrate on one sector and invest in another irrelevant sector so that the returns can be maximized or the losses can be offset.
Those who invest in hedge funds are often known as accredited investors and they need to have a certain level of income or assets. Some examples of those accredited investors may include pension funds, high-net-worth individuals, and insurance companies.
In general, there are huge fees involved with hedge funds, i.e., management fees and performance fees.
Private Equity
Simply, private equities are the stocks of non-listed companies.
This means that a company, before becoming listed, can offer private equity opportunities.
And when this happens, institutional investors or investors who can invest larger sums of money are offered a stake in that company. This is done by the company when it needs money to reinvest in itself for making changes to its business.
However, private equity funds are pooled investment vehicles that have controlling stakes in both public and private companies.
Such funds usually play a key role in handling the companies in their portfolios by providing the companies with the capital they require.
These funds usually have a primary objective of offering capital and improving growth in such companies.
Profits arise for these funds when the stakes are liquidated when the company goes public or gets purchased by another company.
There are different types of private equity investments.
Distressed Debt Investing
This mode of private equity involves entities purchasing debt from an underdeveloped company to help it achieve its profits.
In simple words, assume that a company is having debt and it requires financial assistance to keep on going. In that situation, some other firms will come to its rescue and help it with its debts so as to let it keep running.
Once the company becomes profitable again, it can liquidate its stake by selling the ownership it has.
Fundraising
Through this method, investors usually get the capital they need from a limited partner and form a fund, which is known as a private equity fund.
The pooled investments, i.e., capital raised, are utilized for investing in other companies to derive profits.
Leveraged Buyouts
Also known as an LBO, a Leveraged Buyout means the process of investing in a struggling company.
Such struggling companies usually have the potential for higher growth, and after getting the adequate amount of funds they need, they become profitable.
After becoming profitable, the company pays its debtors back as it is performing better than it used to perform.
Real Estate Firms
Entities known as Private Equity Real Estate Firms use the capital, they raise from investors, to purchase real estate properties.
Such opportunities are only made available for accredited investors and those with higher net worth.
There are some risks involved with commercial real estate, especially when it comes to purchasing such properties and financing them.
Advantages and disadvantages of investing in private equity
- Advantages
— Raising money for a company or a startup might become hard, and at such a point, private equity offers the necessary capital.
— By investing in such opportunities, if the company does grow in the future, the returns are effective.
— Allows for the diversification of the portfolio with a great opportunity for hedging the losses from any other investments in the portfolio.
— Public market scenarios do not have much effect on these investments because they avoid high-interest loans.
— As companies get the necessary capital needed to develop their business activity, the chances for losses are less likely. This is because the company receiving the capital can try different strategies for growing their businesses.
- Disadvantages
— One major drawback is that the scope of losses is not completely zero. This is because the companies are already struggling and that’s why they opted for private equity funding in the first place.
— Such investments require a lot of capital upfront, which may be hard for some people to access.
— The process of these alternative investments can be very lengthy, which makes developed businesses seem more lucrative to invest in.
— The private equity market is not as liquid as other financial markets, and therefore, you may not be able to get off when you need your funds back.
Conclusión
This article is provided for educational purposes and none of the information is treated to be actual investment advice. I neither endorse nor am I against any of the investment options mentioned in this post.
I have covered real estate, precious metals, hedge funds, and private equity, which are among the important types of alternative investments.
I have written 2nd part of this post covering some more alternative investments along with their pros and cons.
Different types of people have different types of financial goals and investment needs. Depending on your financial/investment objectives, only a financial professional can suggest suitable investment opportunities.
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Adam es un autor reconocido internacionalmente en temas financieros, con más de 830 millones de respuestas en Quora, un libro muy vendido en Amazon y colaborador de Forbes.
