Institutional and accredited investors, along with other players equipped with substantial capital coupled with experience in dealing with complex financial assets, have long valued alternative investment as a means of diversifying their portfolios. The broad term “alternative asset” refers to non-paper assets that can be anything from collectables like artwork to commodities or real estate. Today, this asset class is becoming more attractive and easily accessible to investors with smaller portfolios.
The current pandemic-related uncertainty in global markets highlights the importance of diversification in investment portfolios. In addition to mixing different traditional asset classes like cash, stocks and bonds, more and more investors hedge even further with alternative assets. As diverse as alternative assets are, they share one thing in common: investing in them requires highly specialized knowledge.
As alternative assets are generally illiquid and unregulated, understanding their value is up to the investor. If you acquire a work of art that is later revealed to be a forgery, for example, your only recourse would be legal action against the seller, who may be impossible to locate. On the other hand, collectables such as classic cars have shown considerable appreciation. Here, we look at the main categories of alternative investment assets.
The scope of collectable items is virtually infinite. They are generally physical objects, which the investor personally owns. Fine art, vintage cars and rare coins or stamps are widespread collectables, but the category also includes more exotic items like fine wines. To realize a return on investment, it is necessary to find a buyer for a given collectable, which can be challenging. Certain types of collectables go in and out of fashion, with auction results the only guidelines for determining their value.
As physical materials and natural resources traded on the market, commodities such as gold, oil and natural gas or cereals are subject to volatility driven by supply and demand. Typically, commodities move in the opposite direction to stock and bond markets, making them an attractive hedge. Alongside the option of owning the goods outright, investors can purchase shares in commodities and receive dividends when their value rises.
A highly speculative investment product, a derivative is in essence a bet between two or more parties about the changing value of an underlying asset. Derivatives can be used for risk management, pure speculation or leverage, the most widespread types being futures and options.
Futures are contracts to transact a given asset — a commodity like grain, for example — at a set price at a later date. If the market price drops below this agreed price, the seller profits from the difference. If the price rises, on the other hand, the buyer benefits. Options function similarly, but offer the opportunity to buy or sell without obligation.
Capital invested in privately held companies or partnerships is referred to as private equity. It can represent a straightforward investment in the company’s future success. But private equity investors often become directly involved, and make changes to the organization to boost its value. A return on investment can then be realized by selling either the company itself or the acquired ownership stake. Private equity investment typically involves massive amounts of capital, placing this asset type out of reach of most investors.
Investment in real estate is widespread and familiar. It can take on many different forms, from traditional home ownership to investment in rental properties like apartment buildings or shopping centers. Investors can profit through rental income and/or resale of the asset after an increase in property values. There are both conservative and highly speculative approaches, such as purchasing properties believed to be undervalued reselling them on a short-term basis. This practice — flipping — played a major role in the real-estate bubble that triggered the financial and economic meltdown of 2008.
Consider your alternatives
Alternative asset investments may not be the right approach for every investor, but they definitely deserve consideration, especially as financial instruments to diversify your portfolio and hedge against negative trends in traditional financial assets.
A look at the current market reveals a clear picture of how investors view alternative asset classes. In a recent German survey (lifePR December 2020), almost 90% of respondents said they plan to maintain or increase their allocation to these segments in the wake of the corona pandemic. Even more than 90% stated this for their long-term portfolio allocation.
However, their inherent illiquidity and intransparency should be born in mind. While successful investment strategies always require in-depth knowledge of the assets involved, alternative assets demand a heightened level of expertise. If you find this complexity intimidating, but are still interested in exposure, you can also look into publicly traded vehicles that invest in alternative asset classes. For some investors, stocks or funds that include alternative assets might offer the best of both worlds.
Originally published at https://www.area2invest.com on January 12, 2021.
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