December 20, 2023
Investing your capital is the best way to generate income passively. Investors constantly look for new and exciting investment opportunities with a reasonable potential for profit. Alternative investments can be just such hidden gems of financial markets.
Let us dive deep into the versatile world of alternative investments and see where these opportunities are to be found in 2024.
What are alternative investments?
Traditional asset classes are mainly stocks, bonds, and cash. Thus, funds invested in these assets are considered traditional investments. These assets are traded on stock and bond markets and by exchange-traded funds as securities on the secondary market.
Conversely, alternative investment is investing capital in alternative assets. These alternative investments are anything that falls outside the aforementioned traditional asset classes.
Alternative assets are very diverse, ranging from real estate to private equity and far beyond. However, some key similarities allow the grouping of all such assets into one broad category of alternative investments.
- They are harder to sell or otherwise convert into cash than traditional assets.
- Alternative investments are not subject to the same regulatory requirements by US Securities and Exchange Commission (SEC) as traditional assets, leaving more room for speculative investment practices.
- Alternative assets have a low correlation to the stock market and other conventional investments, which means that they do not necessarily react to changing market conditions the way conventional securities do.
- Due to high fees and minimums, alternative investments are usually accessible only to institutional investors, like pension funds and mutual funds, accredited investors, and high-net-worth individuals.
While this is what these financial instruments have in common, it is time to look at the different types of alternative investments to appreciate their diversity.
Different alternative investment types
This broad category of alternative investment includes such different investment vehicles as venture capital firms and private equity funds. Private equity refers to all capital investments made in private companies whose shares are not traded in the public markets.
Private equity funds are similar to hedge funds and mutual funds in that they pool together capital from various private equity firms and accredited investors to invest in private companies.
Private equity funds are usually managed by one private equity firm - the financial advisor that uses the money on behalf of the fund. Unlike mutual funds and hedge funds, however, private equity funds are going after long-term alternative investment opportunities.
Private equity includes both growth and venture capital. While venture capital concentrates on early-stage startups, growth capital focuses on more mature private companies. Unlike when investing in publicly-traded stock, private equity investments are usually followed by investors also providing additional guidance and expertise to their portfolio company.
Private equity firms get a return on their alternative investments either by selling their share in the firms or when they become public companies through the initial public offering (IPO).
Hedge funds are pooled investment funds that employ complex tax structures and trading techniques. Hedge fund managers turn to short-selling, derivatives, and leverage to boost the fund’s performance.
Unlike venture capital firms, hedge funds tend to invest in highly liquid assets like public equity to get the highest possible profit in the shortest period of time. Hedge funds are exclusive to institutional investors, like endowments and mutual funds, and high-net-worth individual investors with relatively high risk tolerance.
Private credit or private debt refers to loans made by entities other than banks. These entities can be private debt funds specializing in such lending or other companies and accredited investors that can provide the loan.
The “private” part refers to the lender not being a bank rather than the borrower. Thus, both private and public companies can benefit from such lending. The lenders generate ROI through interest payments that they receive.
Of all types of alternative investments, real estate is perhaps the most accessible to the broader public. Even those who do not generally invest might have alternative assets in the form of private real estate.
Purposefully investing in real estate is all about valuing particular property types. That requires understanding locations, construction, design, and real estate market trends.
With real estate, income is generated in two major ways. One is waiting for the value to rise and selling the owned real estate. And the other is by receiving constant cash flow from the tenants.
One of the newer and most complex alternative investments, structured products are pre-packaged financial assets containing interest and derivatives like managed futures, swaps, and forwards.
Although the lesser discussed type of alternative investments, structured products in the form of mortgage-backed securities and CDOs attracted attention back in 2007 due to their role in the financial crisis. Thus, investing in these products requires careful consideration and consultation with a professional financial advisor.
This type of alternative asset has probably attracted the most attention from the broader public in recent years. Cryptocurrency is more accessible to lay investors than most other assets on this list.
It also stands out as quite liquid, as exchanging crypto for cash is usually no trouble. And there are many diverse crypto options to invest in. However, 90% of the market is believed to be divided among the top 20 cryptocurrencies.
The cryptocurrency market is very volatile, hard to predict, and laid with scams and scandals. Thus, one should be aware of these dangers before investing big shares of their budget in cryptocurrency.
Tangible assets are commodities and natural resources, like oil, precious metals, land, and agricultural products. Alternative investments in natural gas and oil have the potential for the biggest returns. They are, however, the prerogative of the richest investors and funds.
By investing in forests and agriculture, other investors can generate returns depending on wood industry trends and agricultural commodity prices.
Collectible items are a subclass of tangible assets worthy of separate attention due to their diversity and specifics.
Collectible items are tangible alternative investments purchased and kept with an informed expectation that their value will grow over time. Better-known collectible items that have thus far been used for successful alternative investment strategies include the following.
- Pieces of art;
- Comic books;
- Rare antiques;
- Vintage cars;
- Rare coins.
The list can go on indefinitely and change depending on cultural trends. For example, sneakers have recently been established as investment-worthy collectibles.
Investing in collectibles requires knowledge of particular fields and the ability to keep the item safe and in top shape for years.
Advantages and disadvantages of alternative investment assets
All fields of investment have their benefits that attract some investors and drawbacks that motivate others to put their money elsewhere. The same goes for alternative investments. Here is a table of the pros and cons of investing in alternative assets to help you decide if this is for you.
|Advantages of alternative investments
|Disadvantages of alternative investments
|Opportunities for diverse asset allocation. With alternative investments, you can diversify your portfolio mitigating risks and increasing overall returns.
|Significant risks are involved. Many alternative investments run higher or type-specific risks, like the potential destruction of tangible assets.
|Private markets have a low correlation with stock and bond markets. Thus, turmoil in public markets might leave your alternative assets untouched.
|Illiquidity. Alternative investments are harder to convert into cash or a traditional financial asset quickly.
|Potentially high capital appreciation. Some types of alternative investments can have large returns in relatively short periods of time.
|Most types of alternative investments are out of reach for retail investors.
|Lower volatility of private markets as compared to the stock market.
|Lack of regulation increases the risk of scams and unwarranted speculation and can lead to great individual and economic losses.
|Some alternative assets, like oil, gold, and other natural resources, can help hedge inflation.
|Opaqueness. Without adequate regulation, there is no transparency in the private markets. Thus, it is harder to attain relevant information about some alternative investments.
|Alternative investments provide an opportunity to invest in something you are passionate about, like art or vintage automobiles.
|Valuation challenges. A lot of alternative investments are difficult to evaluate methodically and depend more on subjective attitudes.
How to find alternative investment opportunities?
One of the main challenges of alternative investments is that many private markets are hard to peer and understand. To overcome the obstacles put up by the lack of transparency, one has to take an active interest in alternative markets and find reliable sources of information.
Consulting field experts
In some cases, you would need to become an expert in particular fields or consult one to find the best opportunities. For example, profitable trading in paintings requires understanding the art of painting itself and art world trends. Even with such an understanding, it is advisable to employ the services of professional consultants when making evaluations.
Using public web data
For other alternative strategies, what one needs the most is data analytics. Only information can break the thick walls of private markets and unveil investment opportunities.
Alternative investments require public web data as such data is as versatile as the investment types themselves. Such types of alternative investments as real estate, private equity, and hedge funds can benefit greatly from leveraging relevant data.
For example, venture capital firms can use startup data to identify the most promising early-stage companies before others do. This alternative asset class can also leverage company funding data to learn about the current financial stance of various startups.
Corporate jet tracking is another source of investment intelligence that has succeeded in the past. Tracking major investors to anticipate deals can lead to profitable decisions both in traditional and alternative markets. One has to be careful with such data, however, as it can also lead to speculation.
In real estate investing, satellite imagery and geolocation are great sources of data. For example, geolocation data can help look into renting trends in particular areas, providing valuable investment insights.
Getting a financial advisor for investing in alternatives
Traditional and alternative forms of investment have many differences. Thus, even having experience in the former does not guarantee good results in the latter.
When getting started in alternative investment, it is wise to seek guidance from someone experienced with it. Luckily, some consultancy firms and accredited investors have expertise in alternative markets and can serve as financial advisors.
Such advisors can point out investment opportunities or provide you with the know-how in seeking them out. Whether it is help from a friend or a paid service, doing it with someone else mitigates the high risks of investing in alternatives.
How to invest in alternative assets
The options you have for investing in alternative assets depend on your financial stance. Most alternative investments require a considerable budget for accreditation and the actual investment.
You can also be accredited by SEC by having a proven track record in investment and certifications of expertise. Accreditation provides privileged access to angel investments, venture capital, hedge funds, and other alternative investment opportunities.
Another way is to be part of a firm in which accredited investors own equity. Such an entity would itself be considered an accredited investor.
Mutual funds and ETFs can provide access to alternative opportunities for those without accreditation. Once again, however, the price of investment would be an obstacle for many.
Buying cryptocurrency and currently cheaper items with the potential of becoming collectibles are more accessible ways to invest. However, the potential of such assets is extremely hard to evaluate, which raises investment risks.
Alternative investing is very versatile, exciting, and has the potential for high returns. The chance of losing big is always there as well. Thus, when considering such investments, one must acquire as much data as possible and consult field and investment experts.
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