What are Alternative Investments? | 6 Main Alternatives

Looking for an alternative to traditional asset classes like stocks, bonds and cash? You need to consider alternative investments, otherwise known as alternative assets.
Arguably most investors don’t need to stray beyond the tried and tested conventional categories of investments i.e stocks, bonds and cash... BUT

Did you know that the ultra-rich have half of their wealth tied-up in alternative investments?

That’s according to a survey conducted in 2020 by investing firm KKR. It would appear these ‘alternatives’ might be worth knowing about! While traditionally the hunting ground of institutional investors, many exciting alternative investments are becoming more accessible to retail investors.

Contents: Alternative investments

  • What are alternative investments?
  • What are common alternative investments?
  • Are alternative investments worth it?
  • How do I invest in alternative investments?
  • Alternative investment funds

What are alternative investments?

The name is a clue - alternative investments are any alternative to the normal items in an investment portfolio i.e. stocks, bonds and cash. Alternative investments are also referred to as alternative assets.

alternative investments in portfolio
The word ‘alternative’ might sound like these investments are something kooky but it's likely you already own some of them, like property or classic cars. There is a wide mix of investment types that fall under the bracket of ‘alternative’ and they will all suit different types of investor with different investing horizons and tolerance for risk.

Commodities like spot gold (XAU/USD), CFDs and cryptocurrencies are all officially types of alternative assets. We will cover the most popular alternative investment types next.

What are common alternative investments?

There are 8 types of investments that investors typically think of when they want to add some alternative investments into their portfolio.

1 Real estate (Property)

Real Estate, despite being dubbed an alternative, is the world’s biggest asset class. With rising populations, standards of living and inflation - the price of property tends to rise over time. People are familiar with housing from their own lives, making it a popular choice among those who like to have real assets alongside intangibles like equities and bonds. Investors typically aim to receive a rental income from either residential or commercial property. Then if the price of the property rises over time, real estate offers both income and capital appreciation.

Individual investors can buy a house as an investment or invest in property funds that invest in a wide range of properties - perhaps including commercial property that would otherwise be too costly. The biggest problems with buying and selling real estate are the high transaction fees from brokers (estate agents) and valuation.

2 Commodities

Commodities are another example of ‘real assets’ - typically natural resources like gold, oil or agricultural products. Commodity prices move according to supply and demand, which can often be hard to predict without detailed industry knowledge. For example demand for coffee has grown over the last two decades but there will be occasional supply-shocks when there is a bad harvest in growing-countries like Brazil.

FlowBank offers trading in commodities via futures, CFDs and ETFs.

3 Hedge funds

Hedge funds get their name from the original funds that hedged their investments in stock and bond markets by taking out short positions too. These days hedge funds employ hundreds of different trading strategies. They will typically invest in liquid assets but take higher risk with the use of leverage or derivatives.

4 Private equity

Just as the name implies, private equity is investing in the equity of private companies that are not listed on a stock exchange like the Swiss Exchange (SIX). Private equity is typically divided up into two categories:

  • Buyouts - buying a whole company with the aim of re-selling it for more later.
  • Growth or Venture capital - taking a part ownership stake either in startups or mature companies to help it grow

5 Private Debt

If private equity is the private version of the stock market, private debt is the private version of the bond market. Private debt is a way companies can borrow money not from a bank or from bond markets. Either private or public companies can issue private debt to raise capital.

6 Collectibles

These investments are grouped together as anything that one might collect. It includes art and antiques, stamps & coins, classic cars etc. These are quite possibly the most fun investments! If you can own a bit of history, even use it and it’s value grows - it’s a win-win! The problem with ‘collectables’ is that often beauty is in the eye of the beholder.

Are alternative investments worth it?

Let’s talk about some of the pros and cons of alternative investments.

Advantages of alternative investments

Diversification

The main reason to want to invest in alternatives is diversification from stock and bond markets. These investments tend to have very low correlations to conventional assets so if there is a bear market, these assets can offer a hedge.

Inflation hedge

Investments in hard assets, such as gold, oil, and property have traditionally shielded the wealthy against inflation. Inflation means the reduced purchasing power of money, but hard assets will hold their value by getting pre-priced in more of the devalued currency.

Disadvantages of alternative investments

Illiquid

If an item is very unique it cannot be easily interchanged with the same or similar items, and that will mean there are less transactions in it. Your 100 shares of Apple stock are worth just as much as the next persons’ and Apple has issued millions of shares. This is a different story to your 100 bottles of ‘98 Chardonnay.

Valuations

Knowing how much your investment is really worth is of course the challenge every investor faces but this can be even harder in alternative investments. Often a niche understanding is required to know if it is a good investment or not.

High minimum investments

Some alternative investments like hedge funds will have specific barriers to entry like a $1 million minimum investment or high fee structures like the ‘2&20 rule’ of charging a 2% annual fee and 20% of profits. Some alternative investments are restricted to institutional investors or accredited high net worth individuals (In the US this means a net worth exceeding $1 million, not counting their residence, or a personal income of at least $200,000).

Unregulated

Because of the loose regulation, alternative assets are probably one of the investment categories most susceptible to fraud. The true price and ownership of the assets being invested in are more opaque and so extra due diligence is required.

How do I invest in alternative investments?

For those of us whose invite to Davos got lost in the mail... there is a new way to invest in alternatives without directly getting involved yourself. If you like, there is a passive investing approach to alternative investments via alternative investment funds

Alternative funds

Alternative funds are mutual funds or ETFs that invest in alternative assets. These funds will typically focus on a specific area like commercial real estate, unlisted securities or fine wines. As a retail investor, you need to just buy the ETF to match your area of interest.

A quick search for ‘alternative’ inside the FlowBank Pro trading platform shows the following funds and ETFs available to invest in.

 

alternative investments flowbank pro platform

Related articles

How to invest in trend following using Managed Futures ETFs

How to invest in trend following strategies using ETFs

How to Start Investing 5 Simple Steps

How to Start Investing | 5 Simple Steps

How do Funds Work?

How to Pick an Investment (that works for you)

How to Pick an Investment (that works for you)

bg_newsletter