In this low interest rate environment, investors may find it hard to find investments which generate a good return. Alternative investments are asset classes that do not include the traditional ones such as equities, bonds, and cash. In this article we discuss what the pros and cons of alternative investments and explain some examples of what these asset classes are.
Why do investors invest in alternative investments?
Alternative investments can add to diversification to an investor’s portfolio as they do not correlate to the stock market. The rate of return on these alternatives can surpass typical asset classes but so can the level of risk.
- They don’t publish performance results which means that investors may find it hard to evaluate their investments
- There may be high fees associated with this type of investing
- These types of investments may be very illiquid so when the investor wants to exit the position, they might find it difficult to do so.
Examples of Alternative Investments
Investors with a significant amount of money looking for high returns, can invest in venture capital. Venture capitalists look for start-up companies which have potential to grow significantly. Funds from venture capital are usually from institutional investors or high net worth individuals. These investors are buying an equity stake as opposed to facilitating a loan. As it is not a loan, there is a risk that investors could lose all their capital if the business does not succeed.
Private equity is a fund where a group of investors put their money together and invest in companies. It is similar to venture capital except private equity involves buying mature companies that may be struggling and attempts to resurrect the firm by expanding or implementing new ideas. Investors look to profit from their investment if this struggling company becomes more profitable under the private equity management.
Cryptocurrencies have become very popular in the last few years and is considered as another alternative investment. Investors have seen the rapid movement in the price which has encouraged further investment. Bitcoin reached a peak of US$19,783 in Dec 2017 but it is currently (as of 11 Dec 2019) priced at US$7,215.11. This price drop shows how volatile this alternative investment is. We have previously written up an article about bitcoin “The bitcoin bubble – what is a bubble and how are they created?”
Investors can buy vintage wine with the objective of selling it at a later date. These wine bottles need to be stored appropriately so they can sold in good condition in the future. Investors who do not have extensive wine knowledge can invest in a wine fund where the selection and storage of wine is managed.
Similarly to wine, investors can buy fine art as a long-term investment with the goal to sell for a profit in the future. With this type of investment, the investor needs to have a good eye for art to identify a good investment.
Investors who want to diversify from the typical asset classes are investing in farmland. There is increasing demand for food due to global population expansion and also increased consumption from the middle class in emerging countries. Regardless of how the economy is performing, there will always be demand for food.
Investors may also invest in precious metals to hedge a portfolio when the market is underperforming. When the currency is declining in value, investors may want to buy gold to protect their wealth from inflation.
Lauren Hua is a private client adviser at Fairmont Equities.
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