What are alternative investments?
To put things simply, an alternative investment is anything that is not a traditional investment in the mainstream market. In a traditional sense, the mainstream market usually means shares and bonds. Popular alternative investments are private equity, venture capital, real estate, commodities, and distressed debt, but the list can really seem endless.
Venture capital involves providing funding to startups in the very early stages of development with the belief that the up-and-coming company has the potential for immense growth. Normally, the belief is that a venture capitalist should look for a business offering a product or service with low competition, high market demand, and high-income potential. This is called your ideal profitable niche. Investing in real estate today is going to involve some more strategy (and risk) than usual. Rates are low, which means that interested investors can put little money into a ramshackle home, bring it up-to-date, and sell it for a huge profit. Commodities have been proven to bring in some incredibly large returns when compared to the relatively low price paid initially, but these sorts of investments should be made with the assumption that a return won’t be seen for a decade or longer.
An alternative investment is not the same as a hedge fund
Odds are you’ve heard of a hedge fund but aren’t exactly sure how you’d define one. Hedge funds are just a different name for an investment partnership with the freedom to invest serious amounts of money in a wider variety of options than your traditional mutual fund. Typically, hedge funds are comprised of a professional fund manager and a group of investors who pool their money together to maximize profits. In recent years, though, this definition has shifted.
In fact, hedge funds now lack any clear definition due to a variety of permissible asset classes in such funds. A few decades ago, hedge funds were known for aggressive investing styles, going long and short in common stocks (i.e. mainstream market). Today, contrary to the name, some of them do not even hedge their positions in their portfolio. Therefore, it is not easy to label hedge funds as an alternative investment.
Is alternative investment a good thing?
In truth, there is no such thing as a good or bad investment. It’s all about how well the investment is valued for a potential return (also known as profit). If there is an alternative investment that is priced with a comfortable margin of safety, then it is potentially a good investment. Think of it like this: When an investor buys a share in the market, they hope the market keeps going up. When an investor buys an alternative investment, they pray. This distinction is not without significance. The investor must do careful due diligence before investing in alternative investment. Again, it’s all about the investment’s valuation.
With that being said, alternative investments are not totally uncorrelated to the mainstream market. Alternative investments should provide better returns than the mainstream market due to the illiquid nature of investment and the exclusion of market risk. Alternative investment proposals often claim to deliver more stable and uncorrelated returns compared to the mainstream market, but does that mean that alternative investments always outperform the mainstream market and result in bigger profits? Absolutely not. It is unrealistic to expect that an alternative investment is immune to the overall economy and will protect investors during mainstream market declines.
Market condition is more important than market timing
The key to a successful investment does not lie in making sure the market timing is perfect, but rather in the real market conditions at the time of the investment. In other words, the secret to above-average returns is to buy the asset — whether it be a commodity, a piece of real estate, or venture capital — for far less than it’s worth. If investing through a fund, the better strategy is to invest in increments with managers who have consistently performed well, making them prove they have the ability to increase or reduce your investment size as your opinion of the overall market condition changes.
Take the 1990s tech boom, for example. Lots of private equity investments performed well, but eventually, the returns became lacklustre. Take this as a warning not to invest with top-performing managers that have done well in the past — it’s no guarantee for future performance. A better idea would be to diversify your investment with consistently well-performing managers in each field. Paying this kind of close attention to the market condition will pay off far more than putting all your energy into market timing.
What to look for before investing in alternative investment?
If you’re hoping to pursue an alternative investment, there are a few things you need to be on the lookout for. These tips and tricks will keep you from blindly investing and keep you on the path to a successful alternative investment.
- Make an investment that makes sense to you and has a sensible approach to investing.
- If investing in a fund, check the credentials of the managers and past performance. Their past performance should be consistent, otherwise, you’ll be taking a much larger risk than you should.
- Look for an investment that gives you the ability to increase or decrease your investments without much trouble.
- Always pursue well-defined exit routes — you can never be too careful.
- Make sure your investment has favourable fee arrangements.
- Resist the temptation to buy too fast and pay too much — if the investment is good, there will be an opportunity to increase it. Don’t rush things.
The Bottom Line
The process of investing in alternative investment will be time-consuming and challenging. At its core, it’s really no different than investing in a mainstream market: Prices are high and changes come fast. At the end of the day, no matter which alternative investment route you pursue, you should very seriously consider going down the path of at least one or two. Investors all over the country are diversifying their portfolio by seeking out alternative investments just like the ones detailed above. They’re risky, yes, but no more so than stocks or bonds. Investing with detailed analysis and discipline in a less orthodox field can make the journey exciting. Regardless of the alternative investment you choose to pursue or the amount of money you choose to invest in it, one thing is certain: the journey will be a real thrill.
