Beyond the conventional asset classes of cash, bonds and stocks lie other investment types that investors can consider for diversifying their portfolios. These ‘alternative’ investment options can include physical assets such as wine, fine antiques and real estate, or investment methods such as private equity and hedge funds.
Alternative assets are not typically the first option a financial advisor would offer a client. These types of investments are not considered mainstream; even their management is not part of a conventional portfolio. The appreciation of physical assets like real estate takes time, so investors acquire them for the long term. Alternative assets tend to be illiquid; for example, if a real estate investor wanted to sell off their property they would need to find the right buyer, which is not something that happens on short notice.
How They Work
Many alternative investments tend to have high initial investment requirements, especially when compared to the more traditional assets such as stocks. They also have less publishable performance data, something that limits the number of potential investors. This creates an almost ‘unregulated’ nature around alternative investments, opening up the possibility of fraud and scams. As such, potential investors must conduct due diligence when investing in alternative assets.
Another important aspect of alternative assets is that their prices are dependent on the sale of equivalents. This makes gauging the supply and demand for such assets hard. In the case of antique items, for example, the lack of a central exchange to regulate values might mean that trades will be done through some form of guesswork on the real value of an item, or from previously related sales. From a general perspective, alternative assets tend to be beloved by people with a passion for them; hard data does not fully guide their decisions.
Kevin Neal, a former independent financial advisor with years of experience, understands the value of alternative asset classes in modern investing. While working at Bluefin Capital, he was part of the team that distributed investments into property and alternative asset classes for the company while backed by over 500 million of assets under management (AUM).
The Various Alternatives
Potential investors can keep an eye out for some of the following alternative asset classes:
- Commodities: These are tradeable items that are created for consumer use. They’re indistinguishable and include coffee, beef, energy and precious metals.
- Property: This includes both residential and commercial real estate. Additional investments under this class are real estate investment trusts (REITs).
- Private Equity: This refers to investments made into private companies by private equity firms that raise funds from investors who can be both institutional and non-institutional. The invested funds (or capital) are typically recouped when the companies undergo initial public offerings (IPOs) or acquisitions.
- Direct Start-up Investments: Investors can also choose to invest in private companies and start-ups by themselves. This route is often a high-risk, high-reward proposition, so investors must be prepared for any possibility.
- Collectables: These are items which derive their worth from their rarity, a factor that drives up their demand. They include antiques, fine paintings, classic cars, vintage coins, wine and stamps.
- Derivatives: These are financial agreements whose value is based on the performance of underlying assets. Examples of derivatives include futures and options contracts.
- Hedge Funds: These are investment funds pooled together to be invested in various assets or strategies. Hedge funds operate a little like private equity, only these funds are channelled into public equities that are more liquid. With hedge funds, investors can redeem their investments much faster.
For investors, knowledge of both traditional and alternative asset classes can help in their diversification efforts. Diversifying investments cushions against losses and increases the chances of making returns.