When it comes to investing our hard earned money, most of us stick with the common investment options such as stocks, bonds, mutual funds, exchange-traded funds, insurance etc. While these investment options are undoubtedly good, they are definitely not the only ones out there. A whole universe of alternative investment options exists and this post is going to help you become aware of those options. These alternative investment vehicles are a great medium for you to invest your hard earned cash and reap the rewards. If your goal is to retire at 50, it’s even more important for you to know about alternative investment.
What is alternative investment?
Some prominent alternative investment options include commodities as well as real assets such as precious metals, rare coins, wine, and art, hedge funds, private equity and venture capital. These types of assets perform without much correlation with stocks and bonds. They are also slightly more difficult to evaluate and more often than not, lack the liquidity of traditional investment methods (to encounter that, liquid alternatives have been developed as an asset class over the last few few years. Liquid alternatives include publicly traded mutual funds and ETFs that mimic the performances of an alternative asset class. However, we won’t be talking about liquid alternatives in this post, that’s a whole new topic for some other day).
With some exceptions, only accredited investors are able to invest directly in the assets described above. This restriction exists because many fund managers rely on private placement registration exemptions that limit their investor base to sophisticated investors. These investments are growing in popularity as institutional investors including pension and endowment funds are increasingly allocating money to alternative investments as they realize the long-term benefits of this asset class.
The Yale endowment model is a case study on the benefits of hedge fund and private equity allocation. Of its $23.9 billion endowment fund, Yale University has allocated 33% to private equity. This represents a significantly larger amount than any other educational institutions in the United States of America. The Yale endowment generated 20.2% in returns in fiscal 2014, far outpacing most endowments, and has gained 11% per year for the past 10 years.
Regulations limiting many kinds of alternative investments to accredited investors are meant to be both a sophistication test as well as a protective measure. Opening these alternative investment options to the retail market requires extensive legislation and it hasn’t been finalised yet. The alternative investment options featured in the ensuing list are meant to be a snapshot of the different opportunities that exist in a huge and increasingly complex private capital marketplace.
Widespread technology proliferation has provided investors with a direct path towards investing in alternative investment options. It is recommended that investors consult a trusted financial advisor on what investments fit appropriately within a given portfolio and risk tolerance. Before putting their money into any alternative investment tool, investors must completely understand the fund’s investment strategy and only consent to as much as risk as they are comfortable with. On top of knowing everything about the alternative investment option, potential investors should also do a thorough background check of the investment professionals who will be handling their money. Investors should keep their eyes open towards the investment professional’s reputation in the market as well. Although the Securities and Exchange Commission does not regulate certain private investments, many managers are registered as investment advisers with the SEC or state securities commission. By accessing the SEC’s Investment Adviser Public Disclosure Web site or North American Securities Administration Association website, investors can review the information about the adviser’s fund.
While many of these types of investments aren’t yet available to retail investors, quite a few of them actually are.
Here are some of the most prevalent types of alternative investments:
As you might be aware, private companies outnumber public companies by a huge margin. A lot of private companies are looking for investments and gladly take in investor capital. Private equity as a term broadly encompasses the private capital market’s entire investment spectrum. Investment strategies differ from one private firm to another and they all have their area of interest/expertise. Most private equity firms raise their capital from institutional and non-institutional investors. So the fund raising methods remain quite flexible. The funds which are raised by the private equity firms are then used for investing in new but promising private firms. The investors receive their capital, minus the management and performance fee upon an exit event such as an acquisition or an IPO (Initial Public Offer). As mentioned, private equity is a general classification that includes the investment in start-ups, venture capital, and financing throughout phases of a company’s growth.
Direct investments in start-ups and private companies
Investors can directly invest into start-ups and private companies as opposed to investing in a private-equity fund. Investing seed capital directly in start-ups is sometimes referred to as angel investing. This is a high risk and high return strategy for investors as many start-ups end up failing. A private company will seek investors through a private placement based on a certain valuation. Retail investors can participate in some offerings depending on the type of registration exemption the company relies upon. Investment capital is something that is sought by Companies throughout the entirety of their life cycles’. So, it’s not always necessary to invest in an up and coming company, investments can also be made in an established company that has existed for a while.
Venture capital firms specialize in investing in the nascent stages of a promising company. Venture capital is also a subset of private equity. Venture capital firms specialize in investing during the early stages of a company, typically a time when companies are in dire need of capital to move forward. This source of capital is crucial for start-ups and early-stage companies that have no access to public financing as most of them lack extensive operational or revenue history. Venture capital firms deploy the funds into different types of companies in a variety of areas. Venture capital firms invest in companies across industry, geography and the funding stage. Venture capital is typically a risky asset class, but can produce outsized returns upon a successful liquidity event. Early venture capital investors in famous start-ups like Google (GOOGL) – Get Report, Facebook (FB) – Get Report, and Twitter(TWTR) – Get Report often make significant returns.
These are pooled investment funds that are formed to invest in a variety of strategies and asset types. The managers of hedge funds usually raise funds and invest using a multitude of financial instruments and styles. Equity long-short, distressed assets, arbitrage, and macro-trends are some of the frequently used hedge fund strategies. The biggest difference between hedge funds and private equity and venture capital funds is that hedge funds generally invest in public equities with greater redemption frequency and enhanced liquidity, allowing investors the flexibility to get their money out more often.
Private placement debt
One of the largest and most prominent markets in the alternative investment space is debt investment. Private placement bonds aren’t issued or traded publicly. Similar to equity, they are also not required to be rated by any certified credit rating agency. Promissory notes or mezzanine debts are often used to finance a private company, while giving investors a steady stream of cash flows.
Real assets are physical or tangible assets that have intrinsic value such as real estate, oil, precious metal commodities, and agriculture land. Luxury and collectible goods such as art, jewellery, artefacts, special issues of books, wine and even classic baseball cards belong to this category. Investors looking to invest through this alternative investment medium can purchase the real assets directly from a seller or through an auction. They can also invest in funds which specialize in real assets.
Fund of Funds
These are large vehicles that form funds to invest in other alternative investment funds. Investors inherently gain diversification by investing in multiple managers, strategies or asset classes.