Adding alternative investments to an investment portfolio is a common practice among retail investors seeking to reduce risk through diversification. There are many different types of alternative investment, many of which enable the investor to hold tangible assets and others that are simply different from traditional investments, such as debt or private equity. The embedded PDF gives a brief overview of what makes an investment alternative and what purpose alternative investments serve within a portfolio.
Lenn Mayhew Lewis is director and a shareholder of Core Capital Advisors, with Core Capital Europe having a primary focus on the proprietary trading of exotic currencies.
Types of Alternative Investment
An alternative investment is basically any type of investment that falls outside of the traditional asset classes of stocks, bonds and cash. As such, there are hundreds of possible investments and investment vehicles available, so the savvy investor needs to be willing to spend some time researching their chosen asset class before committing. Historically, private equity and debt have been the most commonly utilised alternative investments for portfolio diversification, but there are many options available.
Almost any investment in a tangible asset is classed as alternative, so the commodities markets, real estate, cryptocurrencies, fine wines, art and other collectibles all offer opportunities to diversify. Hedge funds are alternative investment funds that investors can buy into, or they could look at getting into venture capital. Intellectual property is also a type of alternative investment, looking at assets such as trademarks, patents and copyrights. Real estate investors could consider investing in a REITs fund, which you can learn more about in the short video attachment.
Advantages of Alternatives
One of the main advantages of alternative investments is that they often hold an inverse correlation or no correlation to the markets for traditional asset classes, thereby hedging against risk and altering the volatility exposure of the investor. However, there are many other advantages and appeals across the different types of asset that draw in certain types of investor.
For some assets, the investors take great pleasure in what they own above and beyond their potential monetary value. This is particularly true for collectible assets such as art, classic cars, wine and other tangibles. Other investors may get an intellectual and emotional lift from investing in something such as venture capital, where they can use their financing and business knowledge to help a new business get off the ground. Yet others may have insider industry knowledge that lets them take advantage of promising periods in the market for buying or selling a particular asset that other investors may not be aware of.
In the infographic attachment you can see some of the most potentially profitable types of alternative investment in the UK at present.
Drawbacks of Alternatives
Alternative investments are by definition not mainstream investments, which means it can be much harder to obtain the knowledge and information necessary to make careful investments. Depending on which alternative asset class the investor is interested in, they may find that product availability is limited. Conversely, once an asset has been purchased, the owner may find that there are a limited number of potential buyers, making that asset highly illiquid. Alternative investments in the whole are long-term, so they are not suitable for investors looking to make money quickly. Alternative investments such as private equity, debt or hedge funds may have a prohibitively large ticket size that places them out of reach of all but high net worth or institutional investors.
The right alternative investments can reduce the volatility of an investment portfolio and bring pleasure to the investor.