Trading 101: Alternative Investments

Alternative investments can open the door to diversifying your portfolio and building some great profit over the years. When you think of investing, you probably didn’t think of annuities, angel investing or even art! But alternative investments can protect against risk by mixing up what you invest in. 

Alternative investments have: a low correlation with traditional assets (stocks and bonds); low liquidity; and limited market data which can benefit investors if stock markets are rocky.

What are alternative investments?

An alternative investment is a financial asset that is not conventional (stocks, bonds and cash). Usually, alternative investments are held by institutional investors due to the complexity of transactions making it easy to manage for you as the professionals do all the work. Alternative investments include private equity, hedge funds, property, commodities and other tangible assets, and tend to be mostly illiquid. Real estate, fine art, antiques and commodities fall under the class of alternative investments. 

Alternatives make use of the inefficiencies in the market with new and innovative strategies cropping up all the time. They tend to be less liquid and involve more complex strategies than typical investments. The signing up process is also more complex as alternative investments are typically non-registered securities. This makes alternative investments an easier and more effective strategy for investors with a qualified purchaser status. 

Alternative investments contain the same asset classes as typical investment portfolios including equities, fixed income and real assets. The aspect that makes alternative assets so different is the structures and strategies used. There are two types of alternative investments, the first are private assets such as private equity, private credit, infrastructure and property. The second type is hedge funds which operate in the public market. Alternatives offer some liquidity but not as much as conventional investments making it harder to withdraw your money in the short-term.

Hedge funds usually invest in listed securities whilst benefiting from the inefficiencies of traded markets. For example, by making use of a niche type of bond structure to generate more profit. These can then be sold when the investor likes due to some liquidity, although are usually invested in long-term. Private equity, however, makes you commit to a fund who then decides which opportunities to pick and choose over time. Private equity could be investing in anything from buildings to start-ups and is based in highly illiquid assets which only get the investor a return when the asset is sold. 

As alternative investments are out of the box, many people instantly disregard them thinking they cannot possibly turnover as much profit. But this popular opinion just isn’t true! Different alternative investments can yield different amounts which can be difficult to track.  Peer-to-peer lending can yield between 5-9% compared to the S&P 500’s growth of 10-11% a year. 

Research done by RBC Wealth Management found 72% of Americans believe that investors must be more flexible to different investment strategies. Diversifying your investments by allocating some funds to alternatives can make profits through different avenues that don’t rely on the performance of conventional markets.

Are alternative investments for me?

Although the popularity of alternative investments has increased over recent years and can build creative ways to profit from investments, it isn’t suited to everyone. 

You must consider why you are choosing to invest in alternatives to really pick out a specific goal and how you can achieve it. Also consider your risk appetite and how long you want to hold your investment for. Alternative investments are best for those investors who are okay with illiquidity and want to hold their investments long – term, for a decade or more. If you require liquidity for a retirement fund, moving or paying for education then now may not be the best time to invest, but if you have no big liquidity requirements and hold a large pot of money that isn’t working itself hard enough, then investing in alternatives would be great for you. You can think of liquidity as how easy the asset is to sell. A £800 vintage wine has much less demand than 100 shares of Facebook. This may also make it hard to value the item as without having a buyer and other similar items to compare the price, it is difficult to label up a price tag.

There are a few fallbacks which means alternative assets are not for everyone. Alternative investments tend to have high minimum investments compared to ETFs and have less public performance data for investors to analyse. Transaction costs, however, are much lower than conventional assets due to low turnover and less popularity. Something to watch out for with alternative investments is that they are unregulated by the Securities and Exchange Commission (SEC). If an asset is not overseen or regulated by the SEC or similar, it allows opportunist scammers and fraudsters to play. So be careful to do your due diligence and stick to an asset you have specialist knowledge on. 

Alternative investment strategy

Alternative investments have low correlation with conventional asset classes meaning they can move in opposite or completely separate ways to stock and bond markets. If you choose to invest in hard assets like property or gold, this provides a hedge against inflation which damages the purchasing power of money. This means investing in alternatives can protect against unpredictable inflation, making it a good option for long-term investing.

If you are signed up to a large institutional fund like a pension then usually a small part of the portfolio you hold (< 10%) can go towards alternative investments such as hedge funds. This could be an easy option for you to start investing in alternatives.

You could also invest in alt funds or liquid alts giving you the chance to invest in alternative asset types which are difficult and expensive to access as an individual. An added bonus is that they are SEC registered so your investments are protected!

What shall I invest in?

The most popular assets are commodities and real estate holdings followed by hedge funds at 26%. You should invest in an area you are comfortable with, so if you have a wealth of knowledge surrounding property, invest in property, but if your expertise lie in fine wines, invest in fine wines.

eToro have carried out a survey on what alternative investments are most widely searched for on the internet earlier this year by Brits. Not surprisingly property was the most popular asset, followed by gold and rare coins which both have grown a phenomenal amount of interest earlier this year. As people have more time to think about investing and want to make robust investments during the start of the COVID pandemic, alternatives have become more popular. Whilst property’s popularity has remained unchanged, interest in gold has increased 128% year-on-year and rare coins have gained a massive 177% interest year-on-year. The surge in interest in gold and precious metals can be explained by psychology around investing during covid times, with people opting for safe and robust options, where other investment options appear more risky as they are tied to economic performance.

Image from eToro

What alternatives shall I invest in for 2021?

  1. Peer-to-peer lending

Peer-to-peer lending is a service that offers loans for businesses, individuals or pretty much anything. You can loan money to borrowers who qualify under certain terms and then you can sit back and receive repayment each month with added interest. This avenue can provide returns on your investment higher than conventional investment. 

However, with everything, there is a risk. Borrowers who tend to use peer-to-peer lending often opt for this service as they are rejected from traditional loaning organisations such as banks, meaning they are more likely to default. A way to overcome this is by setting a risk level you are comfortable with by only accepting borrowers who meet the criteria you set, such as a certain credit rating.

  1. Gold

You may think investing in gold is backward but it is a strong investment with an interest increase of over 100% since the outbreak of coronavirus. Gold is a tangible inflation hedge, a liquid asset that can store a value long-term. Following the criteria of alternatives, gold is great for diversifying your investments as it has a low correlation with conventional investments such as stocks. There are many ways you can invest in gold from physically holding coins or bars to ETFs or gold accounts.

  1. Equity Crowdfunding

Equity crowdfunding involves you investing in someone else’s business. Startups that need money offer large portions of shares in return, allowing you to grow wealth much above typical market rates. The risk here is that the return depends on the success of the company and it is hard to tell which startups sink and which float when they are in their infancy.

If you want to diversify your portfolio, invest in alternatives to grow your money at a risk level you are comfortable with. For more tips and tricks, use BullBear

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