What’s Beyond Stocks, Bond & Cash

alternative investments

Alternative investments are broadly those investments that fall beyond the conventional investment types, such as stocks, bonds and cash. They may include private equity, real estate, hedge funds, financial derivatives contracts and commodities.

Alternative Investments Methods

Image Courtesy: Consumer Reports

As is the norm with all investments, a basic and coherent understanding of the various benefits and risks associated with alternative investments is quintessential.

Lets start with the obstacles…

A key characteristic of majority of alternative investments is that they are complex in nature. Investors who venture into alternative investments are many at times, high-net-worth individuals. The upfront costs and fee structures of alternative investments are relatively high as compared to conventional investments such as mutual funds.

Due to their complex nature, records of performance data that can be verified are minimal, which eventually results in limited visibility and advertising to prospective investors.

In terms of liquidity, assets in alternative investments are not liquid as compared to traditional assets. This can be due to limited consumers of the unique product or service.

Alternative investments also have a problem of valuation. This is because these investments are not conventional. Thus, nearly every aspect of these investments is unique and not so subtle, especially with producer-consumer relations, interactions, and transactions. Thus, assigning value to transactions may be difficult and the true value of transactions may not be accurately presented.

Conducting due diligence on alternative investments is often a cumbersome affair due to limited regulation. It is time-consuming and costly. At times, prospective investors may lack the adequate tools to conduct such due diligence. This, in the end, may affect them adversely in terms of loss of investment income, misinformation and fraud.

Don’t fear, its not all down hill…

Alternative assets have a lot of merits. One of them is that they have comparatively lower transactional costs even though their initial investment fee is high.  This is majorly attributed to low turnover.

Another benefit of alternative investments is high returns. It is probable that the high risk of such investments translates into high returns for the investors.

Alternative investments can also enhance investment diversification which is at the heart of all prospective investors. Investment diversification reduces risk. It is also a rule of thumb that investing in assets with low correlations to one another further reduces risk. Thus, investing in alternative investments is a good approach to investment diversification.

Tax incentives may also accrue to alternative investments due to their long term nature. Long term investments benefit from capital gains tax.

Investors should undertake alternative investment as one of the ways of diversifying their investment portfolio. With the increase of volatile markets, alternative investment should be considered as a remedy to mitigate this volatility. Due diligence should, however, be undertaken as a precursor to maximize return on investment and to minimize risks.

Share This: