Alternative Assets: Benefits, Sources, and Methods
October 08, 2021
At the turn of the century, many developments have had tremendous effects on the world of finance. The game of investment has already changed and still is changing at a rapid pace. To keep up with it, financial firms and private investors can no longer be satisfied with just the traditional modes of conduct and turn to available alternatives. One of these classes of alternatives is alternative assets, which attracts investors aiming for investment portfolio diversification. This class is supplemented by another type of alternatives – alternative data, a broad category of non-traditional sources of information that is now used in investment. In this article, we will look over both these important alternatives in the investment landscape and how they relate to each other.
What are alternative assets?
When talking about alternatives, one first has to refer to what’s traditional. In investment, standard asset classes are stocks, bonds, and cash. These traditional investments are publicly traded, for example, via stock exchanges in a stock market. Alternative investments or assets are all tradeable goods that are not stocks, bonds, or cash. This means that aside from these three types of traditional asset classes, alternative investment deals with all kinds of goods that one invests in expecting their value to rise over time. Naturally, this makes alternative asset classes very wide-ranging and diverse. Let’s explore them closer.
Types of alternative assets and investors
First, there is a large category of alternative investment types, collectively known as private equity. The common feature of the different types of such alternative investments is capital that isn’t listed on a public exchange. What makes private equity a type of alternative investment is the fact that investors usually offer more than just funding for the private company they invest in. Additionally, such investors use their resources to provide various expertise, guidance, and financial advice to the firm’s management and service providers.
The three major types of private equity are venture capital, growth capital, and buyouts.
Venture capital (VC) is the funding provided to start-ups or early-stage firms with high growth potential. VC investors venture into such developing projects in exchange for equity in the company. Thus, venture capitalists assume part of the risk associated with start-up development but also get a degree of control over it.
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Growth capital, also known as expansion capital, is just that – funds for a relatively mature company to expand. Companies come to private equity investors for growth capital when they have already been in business for some time and now see an opportunity to go bigger or restructure for future benefits.
The strategy that PE investment is perhaps most associated with nowadays is leveraged buyout. When applying this strategy investors use mostly borrowed funds to acquire a company, restructure or otherwise raise its value and eventually sell it.
Hedge funds are alternative investment funds that gather capital from private and institutional investors such as pension funds and mutual funds and invest it in diverse assets for high potential returns. Hedge fund managers employ various investment strategies and techniques, such as market-neutral and long-short equity to achieve the wanted results.
Real estate investing, like investments in other types of real assets is considered an alternative investment since real assets have less liquidity than traditional. Three main types of real estate assets are residential, industrial, commercial properties. Investors can generate income by acquiring shares in real estate investment trusts, which invest in commercial properties.
This is the type of debt that is not bank loans or open market investments. With private debt, investors profit from repayments of initial loans plus interests.
Alternative investments into such natural resources as gold and other precious metals, oil, gas, and grown products have been around for centuries. Investors access various markets for natural resources through exchange-traded funds or a mutual fund.
Everything, from artwork and wine bottles to baseball cards and comic books, can become alternative investments if we can reasonably expect their value to rise.
The newest major alternative asset class is cryptocurrency. Popular cryptocurrencies, first and foremost Bitcoin promise great returns but are also extremely risky due to their novelty and lack of data regarding their long-term effect on the markets.
Traditional investment vs. alternative investment
Traditional assets are usually more liquid as it is easy to trade in cash or cash equivalents. Alternative assets are highly illiquid as there are less interested and capable buyers for unique collectible items or property.
Types of owners
Alternative asset owners are often active, like property owners who are involved in caring for and renting their property. Usually, alternative investments are made by institutional investors, mutual funds, and accredited investors such as high-net-worth individuals, as they often require high minimum investments. However, some alternative assets are becoming increasingly available to smaller individual and retail investors.
While traditional investments are highly regulated by various national and international organizations, due to their diverse nature, alternative investments have less unified and overarching modes of regulation.
Sensitivity to market conditions
Traditional assets are strongly correlated with each other as all of them are the main liquid tradable assets in the market, making their value highly dependent on the general market conditions. Many alternative investments have no such dependency and can go in a different direction than the general market.
Usage of leverage
Traditional investors generally do not use leverage, that is, borrowed capital for investment. Alternative investors use it for some strategies, like the aforementioned leveraged buyouts.
Risk and rewards
Alternative investments bear more risk, as it’s harder to predict the value trends of assets that are less dependent on foreseeable market changes. However, this also means higher potential returns on investment.
Advantages of utilizing alternative data for investment
Variety of information
Even traditional institutional and accredited investors utilize alternative data to boost their investment decisions. But having understood the basics of alternative investments it’s not hard to see that alternative data is especially necessary here. Alternative data is even more diverse than alternative assets, thus it can provide valuable information for all asset classes. From public sentiment data to firmographics, all types of alternative data can help to determine the value of private companies or items that alternative investors might want to trade.
Managers of a financial institution often need to act fast not to miss out on the best investment opportunities. Alternative data sources, like social networks, satellites, and smart devices transmit information immediately. Meanwhile, waiting for industry releases may take a while. Thus, to make decisions efficiently, investors get their news from alternative sources. Additionally, hedge fund managers find such alternative data types like website traffic information extremely important when evaluating a company that is trying to attract investments.
As many as 63% of financial firms that use machine learning, do it for trading and investment idea generation but are held back by insufficient data. On the one hand, it shows the importance of AI-related service providers in contemporary investment. On the other hand, it makes it clear just how crucial varied and high-quality data types are in order to properly utilize machine learning. Training algorithms for better investment models could be very helpful in mitigating the inherent risks of alternative investment. And such training would need to rely on the great volume and diversity of alternative data to increase the predicting power of AI-based tools.
As alternative data ranges far beyond traditional financial asset data, it can provide insights that are simply not possible when using just traditional sources. These are the kind of rare insights that most investors dealing with alternative assets look for. Satellite imagery might show activity in the mines where there are precious metals from around the globe, thus helping to determine the volume of supply and thus market worth of these metals. While social media presence of contemporary artists might have an impact on their public image that translates into acceptance of their art for the following decades. Such examples of insights provided by alternative data are valuable although relatively easy to think of, while the ones hidden deeper in the data are even more rewarding.
To further emphasize the advantages of alternative data for investors, here is an infographic that shows several alternative data use cases in terms of investing.
The importance of data when dealing with alternative assets
As alternative investment is less regulated and consists of various types of assets and modes of conduct, there is much less transparency in private markets than with traditional forms of investment. When dealing with high-value investments and having only a limited understanding of the relevant facts and procedures involved, alternative investors risk making crucial errors. Additionally, insurance companies and individual investors always risk falling victim to fraud.
And when fraud is suspected after the deal, it may take up a lot of time and resources to untangle it, hence the old saying “buyer beware”. Dmitry Rybolovlev, a high-net-worth individual investing in artwork, can testify to that. It was back in 2015 when lawsuits were filed, accusing an art dealer of swindling $1bn dollars from Rybolovlev and the case is still ongoing in 2021.
The only way to mitigate such risks is, of course, by increasing and diversifying sources of relevant information. Traditionally used data sources will tell little about the trustworthiness of a broker or a service provider, or anonymous sellers’ true asking price, and even less about alternative assets that fall further below the radar than artwork.
However, even pieces of seemingly unrelated information openly shared on social media or publicly available historical records may enable investors to piece together the true picture of the conditions they deal with. Because of this capacity to reveal suspicious activity and conquer misinformation, alternative data is one of the top ways to enhance alternative assets.
When doing things in an alternative way, one can no longer rely only on traditional tools. Thus, investors find their path through the broad and dense jungle of alternative investment, by getting directions from alternative data sources. Whatever the asset is, there are always alternative data types relevant for trading it.
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