An alternative investment is a financial asset not falling under the conventional investments categories like cash, stocks, and bonds. Hedge funds, real property, private equity, crowdfunding, and commodities are common types of alternative investments. Pieces of art and antiques also belong to this category of financial assets.
Hedge funds are private, professionally managed funds that operate with pooled capital. Rentals, real estate development companies, raw land, and others can all fall under the real estate type of alternative investments. Private equity usually requires directly investing large amounts in not publicly traded private companies. Often this means investing in new companies with high growth potential.
Crowdfunding uses pooled money from individuals to fund new business endeavors. Investors can receive company equity shares in return. And commodities typically involve investments in raw materials, such as precious metals, electricity, and oil.
Alternative investments usually have higher fees and require higher minimum initial investments than retail-oriented mutual funds and exchange-traded funds (ETFs). They are also more complex, less liquid, and entail higher risk. Thus, typically large institutional investors or accredited, wealthy individuals hold alternative investments.
However, alternatives have lower transaction costs because of lower turnover. This last characteristic and the smaller number of buyers make them less liquid. For example, it can be considerably harder to find a buyer for a 100-year-old bottle of wine than for 1,000 shares of a leading software company.
As for the higher risk, it is difficult to obtain verifiable financial information for alternative investments or advertise them to potential investors as they have fewer opportunities to do so. In the case of private equity, investing in new yet untested companies significantly increases the investment’s risk. The same applies to commodities as their supply and demand are highly susceptible to external factors like the weather or natural disasters.
Alternative investments tend to be subject to less clear regulation than their conventional counterparts. Although the US Securities and Exchange Commission (SEC) regulates alternative investment vehicles, their securities do not require registration. In the case of hedge funds, being less regulated allows their managers to transact a wider range of assets, invest in more complex deals, and apply more complex investment strategies.
For example, hedge funds often use the so-called merger arbitrage, where they concurrently buy and sell the corresponding stocks of two merging companies to realize “risk-free” profits. But the lower regulation has also rendered alternatives more prone to fraud and investments scams. Thus, any investor considering them must conduct thorough due diligence.
The main appeal of alternative investments comes from their low correlation with stock and bond markets and higher potential return. Alternatives usually move opposite to stocks and bonds markets, which means they keep their values during a market downturn. This feature makes them suitable for portfolio diversification and volatility or price swings mitigation. Real estate and commodities like precious metals and oil are particularly good for that purpose. In addition, they also make for an effective hedge against inflation, which compromises paper money’s purchasing power.
Similar to any investment, no return is guaranteed, alternative investments can potentially create higher returns than traditional investments. Furthermore, some alternative investments also offer tax benefits unavailable with conventional ones.
from WordPress https://ift.tt/h02Sm7F
via IFTTT
