Guide to Alternative Investments, Types, Benefits & Strategy

In the past few decades, alternative investments have gained much traction from both portfolios: individuals and institutional investors, and are becoming more mainstream. While traditional investment avenues (stocks and bonds) continue to appeal to several folks, investors are now exploring alternative assets to gain higher returns, generate income, reap better diversification opportunities, and achieve their goals. However, one must note that alternative investments are complex and come with certain challenges and risks that need to be carefully evaluated before diving in!

With this guide, we will try to explain the intricacies of alternative investments, their types, benefits, risks, and strategies for diversifying a portfolio. Whether you are a newbie trying to ace your financial plan or a seasoned investor, this blog will assist you in making informed decisions.

Not only that! At PCR Insights we can help you take your alternative investment strategy a notch higher with our unique financial data aggregation services and take this colossal responsibility off your hands.

What Are Alternative Investments?

Alts, alternatives, or alternative investment is primarily an investment strategy outside conventional cash, stocks, or bonds. These include assets like real estate, collectibles, hedge funds, and cryptocurrencies; therefore, they are often called alternative assets. One of their distinctive features is that they are likely to create an absolute return! Furthermore, irrespective of market conditions, alternatives behave differently and provide a buffer against instability or volatility, thereby reducing overall risk.

It's imperative to note that, unlike traditional investments that are traded easily in the public or exchange markets, alternatives require certain expertise. Moreover, these investments are less liquid and cannot be exchanged or sold for hard cash!

Comparison with traditional investments 

Now that you understand the difference between alternatives and traditional investments, let’s explore some major distinguishing factors:

Importance in portfolio diversification

Diversification is the practice of including more than one type of investment so that there is less exposure and impact on them. By spreading their investments across different types of assets, investors buffer volatility and potentially earn rewards from various investment sources as they mature or manifest over time.  

While traditional assets are largely affected by broader market trends, alternative investments aren’t correlated much with the stock market. Even when the market dips and fluctuates, alternatives may continue to thrive, protecting and maximizing the investor's overall portfolio. These features make them valuable options for portfolio diversification and long-term stability and growth.

Pro tip: You should try financial aggregation to consolidate all your investments in a single place. The holistic view will not only help you track and manage your wealth but also assist you in making informed decisions about your portfolio.

Types of Alternative Investments

Several investments fall under the broad spectrum of ‘alternatives’. Let’s learn about the top-performing types of alternate investments:

1. Real estate: 

Investments in physical property, especially real estate remain one of the most sought-after alternate investments. And if you think it requires a huge amount of money, you are just partially correct! A lot of money is surely needed for personal real estate assets but with the help of REITs (Real Estate Investment Trusts) you can pool capital to purchase or invest in commercial real estate. So, even if you do not have millions in your bank account you can still invest in properties like malls, hotels, and office spaces with REITs. Real estate investments generate capital appreciation and ensure steady income through rental profits.

Key Benefits:

• Offers consistent income through rental yields
• A physical asset with intrinsic value
• Protection against market inflation (property values tend to rise with inflation).
• Private equity and venture capital

Risks:

• Real estate properties are illiquid: They might take a longer time to sell
• Certain market risks, such as dips in demand, interest rates, or other economic conditions, can adversely affect these investments.

2. Private equity and venture capital

Any equity or ownership through investments in companies that aren’t listed on the public exchange is private equity. In simpler terms, private equity organizations raise capital from institutional and non-institutional investors to buy and grow a business only to sell it later to earn bigger profits. Depending upon the need and stage of the organization, private equity funds are generated. Venture capital remains an integral subset of private equity, wherein, the funding goes to help start-ups or early-stage companies achieve long-term success with high growth potential.

Key Benefits:

• Likely to garner higher returns, especially in early-stage investments.
• Direct involvement and influence over the organization’s management and direction.

Risks:

• Extended or prolonged investment timeline. It might even take years to witness returns.
• All start-ups do not succeed! Therefore, venture capital carries a high risk of failure!

3. Hedge Funds

Pooled investment funds or hedge funds are extensive in nature and require high initial investment and expertise. These funds consist of currency and futures markets along with stocks and bonds. A wide range of strategies like derivatives, short positions, and leverage are used to maximize returns and evade risks. Given the high-risk factor, hedge funds are suitable only for accredited or qualified investors with the ability to withstand high losses.

Key Benefits:

• Admission into seasoned investor groups and easy access to sophisticated investment strategies.
• Strategies like short selling offer the potential for better returns irrespective of the market conditions.

Risks:

• High fees (performance-based fees or management fees).
• Less transparent than several alternative investments.

4. Commodities

Real, physical assets, precious metals (gold and silver), agricultural products, and oil are some lucrative alternative investments. They shield your investment portfolio from market struggles while offering decent results. Investors can opt for direct or indirect trading in the form of ETFs or commodity-focused funds. However, these investments remain volatile and can alter with demand and supply fluctuations.

Key Benefits:

• Commodities, especially precious metals, protect against inflation and hold their value.
• Commodities diversify investments and aren’t correlated with bonds or stocks.

Risks:

• Market imbalances: Commodities undergo significant fluctuations arising due to supply/demand imbalances, natural disasters, or geopolitical events.
• Complexity: Individual investors might find it difficult to track and manage these assets. However, with the help of financial data aggregation, this issue can be sorted.

5. Cryptocurrencies

In the last two decades, cryptocurrencies have emerged as a secure alternative asset class as they are hard to counterfeit. Popular cryptos like Bitcoin, Ethereum, and others are protected by cryptography and use decentralized blockchain technology to eliminate middlemen like banks. Safe peer-to-peer transactions, diversification, and innovation draw more investors towards them.

Key Benefits:

• Portfolio diversification: Assures high returns in bullish markets.
• Protection against inflation and currency devaluation.

Risks:

• Complexity: Prone to speculation and price volatility.
• Cryptocurrencies face fluctuation arising due to the regulatory landscape. This can hamper their usage and value.

6. Collectibles

Collectibles appeal more to UHNW (Ultra High Net Worth) investors who seek a diversified portfolio. Tangible and luxury assets like rare cars, vintage wine, sneakers, sports memorabilia, antiques, coins, and even comic books and toys have been long used as stores of high profit and value. While these items are less liquid, they can bring massive returns.

Key Benefits:

• Better long-term appreciation returns.
• In addition to financial gain, tangible assets add to emotional and aesthetic value.

Risks:

• Illiquidity: These assets can take several months and years to get a worthy price and buyer.
• Market risks: The value of collectibles can fluctuate based on trends and demands.

How to Start Investing in Alternatives?

Isn’t it easy to determine why more and more investors are looking for ways to add alternative investments to their portfolios? However, incorporating them into your investments can be a challenging affair even for seasoned institutional investors. Here we bring you the top three ways to go about the same:

1. Finding Platforms or Funds:

Direct purchase or traditional brokerage accounts will not help in acquiring most of the alternative assets. You need to get assistance from specialized investment platforms to buy them. For instance, in the US, you can invest in real estate through Fundrise, CrowdStreet (Commercial Real Estate), Yieldstreet (Real Estate, Art, Private Credit, Legal Finance), EquityMultiple, RealtyMogul, and PeerStreet (Debt). Furthermore, platforms like Artivest( Private Equity, Hedge Funds), AcreTrader (Farmland), Masterworks (Art), SeedInvest (for startups), and Rally Rd. (Collectibles -Cars, Sports Memorabilia) can help you invest with lower amounts than investing in large chunks to buy equity in a company or a property.

2. Minimum Investment Requirements:

As mentioned in the point above, alternative investments demand much higher minimum investments compared to traditional ones. For instance, a hedge fund or private equity may initially require a substantial sum of $100,000 or more! This can act as a barrier for many individual investors. But with the minimum investment requirement designed by platforms like crowdfunding allows easy entry for small investors into the scene.

3. Regulations and Tax Considerations:

Depending on the asset class and its investment structure, alternatives become subject to various regulations. For instance, hedge funds, real estate, or private equity, may have different tax implications, regulatory oversight, or registering and reporting requirements. For example, some US states may offer lesser rates, regulatory reliefs, or exemptions on property taxes or capital gains. But some might not be favorable which can directly impact the returns and overall investment strategy. Therefore, you must consult a tax expert or financial advisor before pooling for alternative assets.

Our financial experts at PCR Insights can help you ensure complete compliance with taxation and other regulations. We can also help you optimize your investment strategies through financial aggregation.

Trends in Alternative Investments 

The nature of alts has traditionally showcased them as elite options for big institutions and ultra-wealthy people, primarily because they aren’t regulated by the SEC! However, these investments are now being simplified for retail investors who can reap the profit potential. Here are two major trends to look out for: 

Rise of crowdfunding and fractional ownership

Thanks to crowdfunding and fractional ownership, assets are increasingly being democratized and accessible, particularly in startup projects, fine arts, and real estate ventures. A broader range of investors with lower minimum investments can now own assets that were once exclusive to high-net-worth individuals or institutions. Initiatives like these foster portfolio diversification and help investors align their ventures by mitigating various risks through shared investment.

Impact of Technology and Blockchain 

Enabling the rise of cryptocurrencies that offer impressive returns, blockchain technology is paving new frontiers for alts in digital assets. Steering ahead from just digital currencies, blockchain is ushering decentralized finance (DeFi) platforms. DeFi facilitates banking activities like trading, lending, and borrowing without the need for any financial institutions or traditional intermediaries. These platforms work with smart contracts to reduce cost, increase transparency, and automate transactions. Not only that! Its ability to tokenize assets like commodities, art pieces, and real estate holdings opens several avenues for fractional ownership facilitating a broader market reach with increased liquidity. 

FAQs on Alternative Investments

1. Who should invest in alternatives?

Alternatives are best suited for high-net-worth individuals, accredited investors, and retired or income-focused investors seeking to diversify their portfolios. Also, people with long-term financial goals and an appetite for higher risk tolerance can opt for alts. 

2. How Much of a Portfolio Should Include Alternatives?

The right allocation for alts varies majorly per individual, depending on factors like financial situation, risk tolerance, and investment objective. However, a common recommendation is an allocation between 10 to 20% of the portfolio. 

Contact us to learn more about our solution and how we can help you streamline your process and elevate your portfolio reporting and investing capabilities.