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.
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:
|
Key Differences |
Traditional Investments |
Alternative Investments |
|
Definition |
Includes conventional assets like bonds, cask, and stocks. |
Includes non-traditional assets like cryptocurrency, real estate, hedge funds, and private equity. |
|
Types |
Exchange Traded Funds (ETFs), stocks, mutual funds, bonds, and mutual funds. |
Venture capital, real estate, hedge funds, commodities, cryptocurrencies collectibles, private equity. |
|
Liquidity |
Higher liquidity: Assets can be converted (sold or exchanged) to cash instantly or within a few days. |
Often less liquid: Assets involve several months and years of holding period, therefore, longer transaction time. |
|
Diversification |
Limited diversification potential. |
Broader diversification options range across various asset types. |
|
Investment Horizon |
Can be favorable for both long- and short-term strategies, allowing flexibility in catering to individual goals. |
Their illiquid nature and significant value appreciation demand a long-term commitment. |
|
Market Correlation
|
Correlates with market performance (mostly). |
It has a lower correlation with conventional markets, thereby, offering a hedge against market recession or downturns. |
|
Market Accessibility |
Easily available information with lower entry barriers makes it more accessible for investors (new or seasoned). |
Along with higher capital, these assets require more expertise and sophisticated knowledge. In certain cases, accreditation can be necessary, therefore, it remains less accessible for average investors. |
|
Risk and return |
Less risky investments offer moderate returns and vice versa. For instance, bonds guarantee stable returns with lower risk, while stocks can offer better growth potential but carry higher risks. |
Offers higher returns with greater risk, like possibilities of complete capital loss in cryptocurrency investments or venture capital. |
|
Ownership and Control |
Stocks and bonds limit investors’ influence or control over the companies they invest in. |
In investments like real estate or private equity, investors have an active role. They can exercise more control, make strategic decisions, and closely monitor the outcomes of their investments. |
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.
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:
Risks:
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:
Risks:
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:
Risks:
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:
Risks:
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:
Risks:
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:
Risks:
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.
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.
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.