Alternative investments are simply investments other than traditional stocks and bonds. Gone are the days when only institutional investors had access to specific investment products. Now, alternative investments are becoming more accessible to retail investors.
Investors no longer rely on just stocks and bonds for investment returns. Understandably so, the traditional financial markets can be volatile. Investors are looking for alternative investment opportunities to diversify their portfolios.
If you want to invest in alternative assets, keep reading to learn more about various alternative investments and things to consider.
Types of Alternative Investments
Common alternative investments are private equity, private debt, real estate, structured products, commodities, hedge funds, and collectibles. Here’s a summary of how these alternative investments work.
Private Equity
Private equity investing is an alternative form of investment that allows investors to buy equity stakes in private companies for possible returns.
Traditional investors buy equity shares in companies listed on the public stock exchange through brokers and intermediary financial institutions. However, private companies are not listed on stock exchange markets, unlike public companies.
Investors can purchase equity in start-ups or private companies directly or invest in private equity (P.E.) funds.
PE funds are managed by general partners (GP) who pool funds from investors —limited partners (LP) to invest in private companies for possible returns. Some PE fund managers also provide management expertise for private companies to help increase the companies’ value and investors’ returns.
Private Debt
Private debt goes by many names. Whether it is called private credit, alternative lending, or non-bank lending, it all means the same thing — loans from non- banks.
Most times, companies raise conventional debt financing through bank loans. Other times, some companies finance their operations through private lending. Some private debt companies like mortgage investment corporations (MICs) provide private real estate lending for mortgages.
Private lending is a widely growing funding strategy. In 2021, global private debt raised was $192bn, a 10% increase from the previous year. Private lending is an alternative way that investors can earn returns. As a private debt investor, you can invest in private lending companies and earn interest as laid out in an agreement.
Private debt arrangements can be mezzanine debt, venture debt, infrastructure debt, real estate debt, MICs, or special purpose debt. Some private debts are collateralized, while others are not backed by any collateral asset.
Hedge Funds
Hedge funds pool money from investors to purchase public securities and other investment assets. As the fifth largest hedge fund market globally, the Canadian hedge fund market is a significant part of the alternative investments market.
Hedge fund managers use strategic investing techniques such as short-selling, leveraged investing, and other speculative strategies to earn returns for investors. In return, hedge fund managers are paid management fees to manage the fund, identify lucrative investment opportunities and manage investment risks.
Total assets under management in Canada’s alternative market have risen by approximately 67 per cent over the past year to about $20-billion today from roughly $12-billion at the start of 2021
Hedge funds typically promise an outperformance in the market based on their investment strategies. Due to their non-conventional investment methods, hedge funds are generally open to accredited investors and institutional investors such as pension funds and insurance companies.
Real Estate
Investing in real estate is a common type of alternative investment. Investors can purchase property directly or buy into public or private real estate funds for investment income and gains.
Like buying stocks on public exchanges, real estate investment trusts (REITs) listed on public financial markets allow investors to buy and sell REIT shares. REITs invest in real estate properties or investments to make returns for investors.
Private real estate investment funds and mortgage investment corporations, also known as MICs, provide alternative opportunities for investors.
Real estate investment funds pool money from investors to invest in real properties. Investors earn returns from the funds through profits from rental income, mortgage payments, or property appreciation.
Private real estate investment opportunities are illiquid because they do not have a public market where they can quickly be sold or bought.
Commodities
Commodity investing allows investors to purchase interests in commodities such as gold, oil, copper, natural resources, or other precious metals.
Investors can buy directly into commodity companies or invest in commodity exchange-traded funds through brokerages.
The upside to commodities investing is the protection over inflation and volatility in the stock market. However, like other investment types, commodities investing has accompanying risks.
Collectibles
An alternative form of investing, collectibles that preserve value and appreciate, allow investors to diversify their portfolios. Collectibles can range from vintage cars to artwork, currency, coins, or even digital collectibles such as cryptocurrency and non-fungible tokens.
The risks involved in investing in collectibles are theft, counterfeits, and loss of value. Investors can secure collectible assets in safety deposit boxes and locks.
Structured Products
Investment firms structure products for investors to earn possible returns. Examples of structured products include special purpose vehicle equity or debt, asset-backed securities, futures, and options.
Structured products are often linked to underlying assets such as stocks, currencies, commodities, or even real estate properties.
Due to their complex nature, investing in structured products involves many risks. Structured-product investments are highly illiquid and often long-term investments.
Why Alternative Investments Are Good
Diversifying one’s investment portfolio through alternative investments is an essential strategy that should not be overlooked. It goes well beyond the popular saying, “don’t put all your eggs in one basket”. Portfolio diversification through alternative investments helps spread investment risks across diverse assets.
High market volatility is not an investor’s best friend. This is where alternative investments often take the lead. The value of alternative products does not fluctuate like traditional investment assets. For example, real estate property prices are not volatile like stock prices.
Also, alternative investments have little to no correlation with movements in the traditional financial markets. In simple terms, this means the prices of most
alternative assets are usually not impacted by stock and bond prices in the financial markets.
It goes without saying that an investor’s primary objective is to make returns. Alternative investments provide diverse sources of returns. In the world of investing, higher returns typically compensate for higher risks. Some alternative investments are complex with higher risks and promise higher returns.
Cons of Alternative Investments
Investing in alternative assets can be beneficial, but before buying alternative investments, here are some things to consider.
Most alternative assets are illiquid. Investors typically need to invest their funds for more extended periods. Also, alternative investments are not publicly-listed like conventional assets. To sell some alternative investment assets, you may need to find a private buyer.
Alternative investment products are most times complex and sophisticated. Some investors consider these types of assets to have higher risks, which are often compensated with higher return premiums.
Due to the complexity and risks involved in some alternative investments, they may be only available to accredited investors, institutional investors, and high- net-worth individuals.
Conclusion
Alternative investments provide diverse ways for investors to earn potential returns. To ensure that these alternative assets align with their overall investment goals and strategy, investors need to conduct in-depth market research before investing in alternative investments.
Generally, investors cannot purchase some alternative investments through registered accounts such as the tax-free savings account (TFSA), or the registered retirement savings plan (RRSP). Instead, investors can buy these investments through investment companies.
Investing in alternative investments is an excellent option for portfolio diversification and serves as a way for investors to spread investment risks.
