• Any asset falling outside the categories of stocks, bonds or cash is considered an alternative asset.
• Among the most common alternative asset classes are private equity, private debt, hedge funds, real estate, commodities, collectibles, and structured products.
• Largely unregulated by the SEC, investing in alternatives can be quite risky. However, the potential rewards can potentially be significant as well.
The traditional approach to investing entails the purchase of publicly traded stocks, mutual funds, and exchange traded funds, as well as fixed-income products such as bonds. However, there is a vast array of other asset classes available to investors. Termed alternative assets, these opportunities go beyond the stock market to offer a number of distinct advantages. Chief among these advantages is the potential they represent for portfolio diversification.
Essentially, any asset falling outside the categories of stocks, bonds or cash is considered an alternative asset. While a wide range of investment opportunities fit into this category, they typically share one or more of the following characteristics.
• Most alternatives are unregulated by the Securities and Exchange Commission.
• These assets can be difficult to convert into cash.
• Correlation to standard asset classes is low. In other words, they usually do not move in lockstep with traditional asset classes, so changing stock market conditions can leave them unaffected.
• In the past, alternative investments were available only to those who had the wherewithal to meet minimum investments of $500,000 to $1 million dollars or more. However, this has changed, as will be discussed later in this article.
Some of the most common alternative asset classes include private equity, private debt, hedge funds, real estate, commodities, collectibles, and structured products.
Private Equity refers to investments made in companies that have yet to be listed on a public stock exchange. It can take the form of venture capital funding startups and business endeavors in the early stages of their development. It can also serve as growth capital to help established companies scale up or restructure. Private equity is also employed to fund buyouts of entire companies, or divisions.
In addition to capital, these investments often entail management assistance in the form of management assistance, talent sourcing, networking, and mentorship.
The goal of a private equity investment is to eventually sell out of it and take profits. As a result, these tend to be long-term investments and highly risky as well. There are no guarantees investments will yield the desired results. However, the rewards they can bring tend to be much higher than those of traditional investments.
Private Debt is similar to private equity in that it helps companies secure funding. However, private debt functions more like a loan than an investment. Companies will often avail themselves of this form of financing to fund growth when they cannot secure it from traditional banks.
Private debt issuers are usually referred to as private debt funds and their profits are derived from interest payments on the loans.
Hedge Funds operate based upon a pooled investment structure. They are similar to mutual funds in that capital from multiple investors is employed to fund a number of different investment strategies with the goal of generating a high return.
Because they operate with minimal SEC oversight, hedge funds are only recommended for institutions, sophisticated investors, and high net worth individuals. This is because while the potential for profit is significant, the consequences of failed hedge fund investments can be very expensive.
Hedge fund managers seek to exploit inefficiencies in the market using tactics such as long-short equity, market neutral, volatility arbitrage, and quantitative strategies. Key to the success of hedge fund investing is finding a fund manager with the skills, experience and expertise required to add value to their investments.
Real Estate is the largest and perhaps most familiar asset class to mainstream investors. In fact, many people already have real estate investments without realizing it. To own a home is to be a real estate investor. The mortgage down payment is indeed investment capital. As the home grows in value over time and the outstanding debt against it is paid down, owners gain equity in the investment.
With that said, when most people speak of investing in real estate they are referring to buying and operating residential or commercial rental properties. Profits on these investments are derived from the rents collected from tenants, as well as the accrual of equity as the value of the properties increase.
Investing in real estate can also be accomplished without individual purchases of properties. Real estate investment trusts pool investor dollars to purchase and operate buildings, distributing shares of the proceeds in accordance with the percentage of ownership individual investments secure. Real estate mutual funds operate like other types of mutual funds, with the exception that their focus is companies that own real estate, rather than properties. Investors can also fund developers and homebuilders.
Commodities include precious metals such as gold and silver, as well as industrial metals such as copper. Agricultural products, along with oil and natural gas, also fall under the heading of commodities.
Their relative lack of sensitivity to the public equity markets makes commodities a potentially useful hedge against inflation. In fact, their prices tend to rise with inflation. The law of supply and demand can also have an influence on the value of commodities. Increased demand means increased investor profit—and vice versa.
Collectibles such as vintage cars, rare wines, fine art and the like have an advantage in that investors can see and appreciate them, while their value increases over time.
Of course, this also means they must usually be carefully stored and maintained. Further, they tend to be highly illiquid, have high acquisition costs and often do not return income until they are sold.
One must be highly skilled to make wise purchases within this asset class. On the other hand, they do tend to bring enjoyment to the aficionado who appreciates them for what they represent as opposed to any profits they may bring.
Individuals can also invest in collectibles without actually owning them. Numerous investment funds specialize in one or more of each area of collectibles. Investors back a curator, who is responsible for caring for the items until they are sold to harvest profits.
Structured Products are fixed-income assets paying dividends. These include government or corporate bonds, as well as derivatives and securities whose value come from an underlying asset or group of assets like stocks, bonds, or market indices.
While structured products can be readily customized to an individual investor’s goals, they can also be extremely risky and complex. Investment banks usually create these products and offer them to hedge funds, organizations, or retail investors.
Structured products of which mainstream investors may be aware include credit default swaps (CDS), mortgage-backed securities (MBS) and collateralized debt obligations (CDO). It should be noted that speculation in CDOs and MBSs is largely responsible for the financial crisis that began in 2007.
Invest In Alternatives Today
As has been mentioned, one of the primary benefits of investing in alternative assets is their lack of correlation to public markets. This can make them useful for portfolio diversification, which is generally agreed upon to be a smart investment strategy.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Of course, like traditional investments, it is important to remember alternatives do entail a significant degree of risk. This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These investors were considered to be more capable of weathering losses of this magnitude should investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Alternative assets offer a number of potentially highly lucrative investment opportunities that go beyond the stock market. However, it’s important to recognize that along with the potential for great reward typically comes significant risk. Investors are encouraged to tread carefully and choose their investment partners judiciously when pursuing strategies incorporating alternative assets.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.