Alternative investments are financial assets that are different from the conventional investment types people usually invest in. These include art, antiques, venture capital, private equity, commodities, derivative contracts, managed future and hedge funds. They have high fees, require additional minimum investment amounts and are significantly illiquid.
Alternative investments lack regulatory oversight and are therefore susceptive to fraud and investment scams even if they don’t involve art, coins, or other such assets. You’ve heard of conventional investments that people put money into all the time. But what are alternative investments? Read on to find out.
What are alternative investments?
An alternative investment is a financial asset that is different from the conventional investment types people usually invest in. While conventional investments usually include stocks, bonds and physical cash, alternative investments include art, antiques, venture capital, private equity, commodities, derivative contracts, managed future, hedge funds and real estate.
Understanding alternative investments
Alternative investment assets are usually unregulated, complex in nature, and bear a higher level of risk. Due to these factors, normally only individuals with a high net worth and institutional investors put money into these investments.
Compared to regular investments such as stocks, ETFs and mutual funds, alternative investments usually require a large sum of money to be invested as the minimum amount. Apart from this, they may also charge high investment fees upfront. However, since these investments have lower turnover levels, their associated transaction costs are usually lower than conventional investments. Investors may also find it difficult to find verifiable data on asset performance in order to make informed decisions.
Unlike conventional investments that can be easily sold for liquid cash, alternative assets are not so liquid. For example, it is a lot more difficult to sell a valuable painting, a 100-year-old bottle of wine, or even an expensive piece of property than to sell a few hundred or thousand shares in the stock market. Also, it can be difficult to appraise and identify the value of many such uncommon assets.
Pros and cons of alternative investments
Alternative investments usually have a low correlation with conventional investments. This means that their movement is in the opposite direction to that of the stock and bond markets which makes them good options if you are looking to diversify your investment portfolio. You can also look at investing in property, oil and gold as they work as a good hedge against inflation.
Due to this benefit of diversification, many large institutions that operate investment funds such as private endowments and pension funds normally have a small portion of their portfolios allocated to alternative investments. These include hedge funds and are usually around 10% of their entire portfolio.
Non-accredited retail investors also now are allowed to invest in alternative assets. These investments include exchange-traded funds and alternative mutual funds which are also known as alt funds or liquid alts. Alt funds give the average investor great opportunities to invest in alternative assets. This was an expensive and difficult process for regular investors till recently. Additionally, alt funds are publicly traded as well. This means that they are regulated and registered with the SEC.
Some of the pros of alternative investments are:
- They move counter to the direction in which conventional assets move.
- They allow for portfolio diversification.
- They often return high rewards.
- They help hedge against inflation.
Some of the cons of alternative investments are:
- They are difficult to appraise and value.
- They are not as regulated as conventional investments.
- They carry a high level of risk.
- It is difficult to liquefy them.
Regulation of alternative investments
Alternative investments lack regulatory oversight and are therefore susceptive to fraud and investment scams even if they don’t involve art, coins or other such assets. The legal structure governing alternative investments is not as clear or rigid as that overseeing the trading of conventional investments.
Practices involved in the buying and selling of these investments are to be examined by the SEC. They come under the purview of the Dodd-Frank Wall Street Reform and Consumer Protection Act. But they are not required to be registered with the SEC and because of this, the SEC normally does not regulate or oversee the transactions when these assets are bought and sold.
Therefore, the onus is on the investors to make sure they gather as much information as possible and conduct ample due diligence before putting money into alternative investments. In many cases, only accredited investors will consider investing in such assets. an accredited investor is a person who has a net worth of more than $1 million (not including their primary home) or a person with an income of at least $200,000 per year.
An example of alternative investments
Even though alt funds are regulated, it does not mean that they are free from risk. Historical data shows that many such funds have limited performance. Although alt funds help diversify an investment portfolio, they still bear the risk of the underlying assets. ETFs that include alternative assets have shown a mixed track record over time.
For instance, as of January 2002, the annualized 5-year return of the SPDR Dow Jones Global Real Estate ETF was 6.17%. For the same period, a return of -6.40% was reported by the SPDR S&P Oil & Gas Exploration & Production ETF.
FAQs on alternative investments
1. How Are Alternative Investments Useful to Investors?
Alternative investments have a low correlation with stock and bond markets. In other words, their values go in the opposite direction as those of regular investments. So, if the markets go down, alternative investments normally will hold their value. Hard assets including real property, oil, gold, etc. offer effective hedges against inflation. Due to this benefit, many large investments institutions hold about 10% of their investments in alternative assets since it helps them diversify their portfolio.
2. What Are Some of the Key Characteristics of Alternative Investments?
The main characteristics of alternative investments include the following:
Compared to regular investments, they have high minimum investment requirements and high fees.
Investors may find it very difficult to get reliable data on their historic performance.
These investments have low transaction costs.
Alternative assets tend to be highly illiquid. They cannot be easily converted into cash.
It can be difficult to appraise and value these assets.
3. Are Alternative Investments Regulated?
Alternative investments are not as regulated as conventional assets. Although they are regulated by the SEC, the securities don’t have to be mandatorily registered. Due to this, there is a high risk of investment scams and frauds happening. Hence, most of these investments are offered only to wealthy accredited individuals or institutions.
