What are alternative investments?

Alternative investments are non-traditional investments – that includes anything that is not stocks, bonds, or cash – or even the use of non-traditional investment strategies. They include such investment vehicles as: precious metals, collectibles, hedge funds, natural resources, private debt (including mortgages), private equity, real estate, and infrastructure.

Once considered to be the prerogative of wealthy investors, the alternative investments sector is becoming more mainstream with interest remaining keen despite the COVID-19 pandemic. Alternative investments are seen as a valuable way to diversify portfolios and, while some may carry a higher risk, generally they are less impacted by market volatility [1]. Extended periods of super-low interest rates have led many investors to seek out investment products that offer higher returns; those who are investing for the long term, including many pension fund managers, are looking to deploy capital into alternative investment vehicles.

In 2020, 40% of institutional investors stated that they would increase investment in private equity, private debt, real estate, and infrastructure, while 30% said they would also invest in hedge funds and natural resources. [2]

Hedge funds

An area that attracts and retains highly skilled managers, hedge funds tend to be less subject to market volatility and reliably add value in the long term. According to BlackRock.com “hedge fund investments provide a level of diversification…that can be hard to find elsewhere.”

Private equity

Investing in private companies is another reliable investment for long-term investors.

Commodities

Some commodities, such as gold and other precious metals, have traditionally been considered inflation-proof; others, however, are more subject to supply and demand. Oil and gas, for example, have been considered safe investments for a long time yet have recently become more volatile following the slump in oil prices. However, opportunities still exist for those wanting to take advantage of the current low prices.

Commodities also include collectibles, anything from artwork, fine wines, and antiques, to baseball cards, coins, and stamps. Collectibles can be higher risk as they are more subject to whims, fancies, and the vagaries of fashion. Many collectors invest because of a passion for the commodity (classic cars, artwork, fine wines, etc.) rather than for monetary concerns.

Real estate

Exchange-traded funds (ETFs) provide low access points to the market for individual investors and can generate immediate cash flow and capital gains. Real Estate Investment Trusts (REITs) are higher risk but offer the possibility of higher returns.

Private mortgages

Investing in private mortgage lending can produce very high returns, with some private mortgage lenders charging as much – at the higher end – as 20% interest, and an average of around 10%; interest rates will usually depend on how high the risk of default is. Individual investors can benefit from investing relatively small amounts of capital in companies that provide private mortgage funds to commercial property developers, or even individual home purchasers. Using the ‘rule of 72,’ an investor could double their initial capital investment in just 7.2 years, given an interest rate of 10%. The risk of default may be higher but reputable – and successful – private mortgage lenders will do their due diligence; as always, the greater the risks, the greater the potential returns.

Alternative investment myths examined [3]

  • Alternative investments are more volatile – in fact, while some may be, alternatives as a whole are no more volatile than other investments and may be far less volatile than the stock market.
  • Alternative investments are illiquid – some obviously are, but investing in alternatives through mutual funds can provide almost instant liquidity and are a good way for smaller investors to get into this market.
  • Only high-net-worth individuals can access alternative investments – this may be true on an individual basis but, as above, products such as mutual funds make alternative investments potentially accessible to all.
  • Alternative investments do not protect investors in market downturns – in crises, such as the financial downturn in 2008, and the current pandemic, coupled with the collapse of the fossil fuel market, all investors will likely suffer to some extent. However, historically speaking, alternative investments have suffered less in such crises than the stock market.

The risk/benefit equation

It goes without saying that higher returns carry higher risks and it is incumbent on individual investors to ensure they have a balanced portfolio with sufficient liquidity to cover short-term needs and emergencies. But a well-managed diversified portfolio should include some higher-risk investments that can generally provide healthier returns in the long term.

Real estate, whether accessed directly, or through ETFs or REITs, has traditionally proven to be a solid investment with excellent returns over time.

[1] Black Rock https://www.blackrock.com/us/individual/education/what-are-alternative-investments

[2] Institutional Investor https://www.institutionalinvestor.com/article/b1lpqb74lrvthq/Special-Report-Optimizing-the-Alternative-Investor-Experience May 27, 2020

[3] Black Rock https://www.blackrock.com/us/individual/education/what-are-alternative-investments

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