The alternative facts
Alternative investments are sometimes defined by what they are not, i.e. not the conventional asset classes of stocks, bonds, funds and cash. So, what are they then? Here are some of the more common categories of alternative investments:
- Private equity – Commonly refers to a fund or group of investors that invest in and/or purchase companies to restructure and then sell them.
- Venture capital – A form of private equity and/or financing that invests in start-up or small – and therefore highly speculative businesses.
- Hedge funds – Investment funds that use complex trading techniques, including short-selling, the use of derivatives and investing in esoteric markets or assets, and deploy leverage to help boost returns.
- Real estate – Typically through an investment fund structure, direct purchasing and selling of real properties, including commercial, industrial and retail, for the purposes of income generation and/or capital appreciation.
- Commodities – Through futures contracts, the purchase and selling of commodities such as oil, gold, wheat and minerals.
Pros
- Diversification: Alternative investments tend to have a “low correlation” to other asset classes such as stocks and bonds. This means they tend to perform in different ways, i.e. when stocks are going down, alternatives may be going up. This provides investors with potential diversification benefits to help reduce risk across their portfolio.
- Inflation hedge: Alternative assets such as some commodities (e.g., oil and gold) and real estate can also perform well when inflation is rising.
- Short selling: Hedge funds are able to “short sell” assets, which means they profit from downturns in those assets, providing another way to diversify.
- Derivatives and leverage: Many alternative investments employ “leverage” (which helps increase the purchasing power of invested capital) and “derivatives” (which can provide access to unique markets with often zero-sum outcomes, i.e., one side of a trade or position “wins” while the other “loses”) with related risks.
- Expanded Opportunity Set: Many alternative investments require a long-term lock-in period, allowing a fund manager to access longer-term investments that would otherwise be unavailable (e.g., land purchases).
Cons
- Accessibility: Alternatives tend to have very high minimum investment thresholds as they are typically offered through an exempt market process, and restrictive qualifiers for investors such as significant net worth and high income levels.
- Lack of transparency: Conventional assets have easily accessible information upon which to base investment decisions; alternative investments can be more opaque, and more difficult to assess as to risk.
- Illiquidity: Long-term lockup periods can prevent investors from accessing their capital, and some investments, such as real estate, can take years to realize a payoff.
- Less regulation: With less oversight by regulators, there’s less transparency for investors as to the risks.
- Fees: Generally, alternative investments have significantly higher fees.
Many alternative investments are high risk and complex, and therefore may not be appropriate for investors with limited investment knowledge or experience, or with a low risk capacity or appetite. This report is intended to be educational only about alternative investments as a general asset class. Should you have any questions or wish to discuss specific investments, please speak with us.
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