Investing your capital is undoubtedly the best way to make passive income. But traditional asset classes like bonds, stocks, and cash alone might not provide the kind of results you seek.
If you’re looking to boost your potential returns, especially in the current world of increased market volatility and unpredictable interest rates, alternative investments are worth a closer look.
Alternative investments include a wide variety of asset options, such as private equity, venture capital, real estate, precious metals, cryptocurrencies, etc., each with its own benefits and unique features.
This guide will explore alternative investments, the common options available, and what you need to get started. Welcome to the world of alternative investments!
What are Alternative Investments?
Alternative investments are assets that fall outside of traditional investment categories like stocks, bonds, and cash. They typically have a low correlation with traditional markets, meaning their value doesn’t necessarily move in tandem with the stock market. This lack of correlation can provide diversification benefits, potentially reducing overall portfolio risk.
Investors often choose alternative investments due to the potential for high returns along with the less correlation with the stock market. For instance, commodities like gold usually gain value during moments of economic uncertainty, while traditional asset classes often lose value in similar environments.
Examples of alternative invesments include:
Real Estate: This includes residential, commercial, and industrial properties, as well as real estate investment trusts (REITs). Real estate investments can generate rental income and appreciate in value over time. However, they require significant capital and can be illiquid.
Private Equity: Private equity involves investing in privately held companies. This may include venture capital for startups or buyouts of established businesses. Private equity investments offer the potential for high returns but often require a long investment horizon and substantial capital commitment.
Hedge Funds: Hedge funds pool money from multiple investors and employ various strategies to generate returns. These strategies can include long-short equity, global macro, and event-driven investing. Hedge funds aim to provide positive returns regardless of market conditions but often charge high fees and have limited liquidity.
Commodities: Investing in commodities involves buying and selling physical goods like gold, silver, oil, and agricultural products. Commodities can hedge against inflation and provide diversification benefits, but they can be volatile and subject to supply and demand dynamics.
Private Debt: Private debt investments involve lending money to companies or individuals outside of traditional banking channels. This may include direct lending, mezzanine financing, and distressed debt investing. Private debt offers the potential for consistent income streams but carries credit and liquidity risks.
Collectibles: Collectibles such as art, wine, rare coins, and classic cars can appreciate in value over time. Investing in collectibles requires expertise in the specific asset class and may involve storage and insurance costs. Additionally, collectibles can be illiquid and subjective in value.
Cryptocurrencies: Cryptocurrencies like Bitcoin and Ethereum are digital assets that use blockchain technology for secure transactions. Crypto investments offer the potential for high returns but are highly speculative and subject to regulatory and technological risks.
More on these later.
Alternative investments offer opportunities for portfolio diversification and, fortunately, are no longer limited to accredited investors. Many younger investors and newcomers to the market can now participate in these options as they have become more accessible.
While many alternative investments are not highly liquid and cannot be easily converted into cash, they have the potential to generate higher yields and provide more predictable income streams.
In times of market fluctuations and falling stock prices, alternative investments tend to be less volatile and do not behave in the same way as traditional assets like stocks and bonds. Including alternatives in your investment mix can add a layer of protection to your portfolio by reducing overall volatility and offering a buffer against market swings.
Types of Alternative Investments
Let us dive deep into the world of alternative investments and explore the different types of alternate investments.
Real Estate
Real estate is arguably the most accessible type of alternative investment for the general public. Even those who typically do not invest might own private real estate.
Purposefully investing in real estate involves evaluating specific property types. This requires knowledge of locations, construction, design, and real estate market trends.
Income from real estate is generated in two primary ways: by selling the property after its value has appreciated and by receiving consistent rental income from tenants.
Types of Real Estate Investments
Residential Real Estate: This includes single-family homes, condominiums, and apartment buildings. Residential real estate investments offer steady rental income and potential appreciation in property value.
Commercial Real Estate: Commercial properties include office buildings, retail centers, industrial warehouses, and hotels. Commercial real estate investments can provide higher rental income and long-term lease agreements but may be more sensitive to economic cycles.
Real Estate Crowdfunding: Real estate crowdfunding involves raising capital from different individual investors who collectively pool funds to buy real estate. This essentially serves as a bridge between the aspirations of the average investor and elaborate real estate projects, providing them with opportunities that are otherwise out of reach for most.
Real Estate Investment Trusts (REITs): REITs are companies that own, operate, or finance income-generating real estate across various property sectors. Investing in REITs offers exposure to real estate with the liquidity of publicly traded stocks.
Pros:
Steady Income: Real estate investments can generate consistent rental income, providing a source of passive cash flow.
Diversification: Real estate has a low correlation with traditional assets like stocks and bonds, offering diversification benefits to a portfolio.
Inflation Hedge: Real estate values and rental income tend to rise with inflation, providing a hedge against purchasing power erosion.
Cons:
Illiquidity: Real estate investments are typically illiquid and may require a long time to sell, especially during economic downturns.
Management Responsibilities: Direct ownership of real estate entails management responsibilities such as property maintenance, tenant management, and regulatory compliance.
Market Volatility: Real estate values can be affected by local economic conditions, interest rates, and demographic trends, leading to fluctuations in property prices and rental demand.
Private Equity
Private equity encompasses all capital investments made in private companies whose shares are not publicly traded.
Private equity funds pool capital from various private equity firms and accredited investors to invest in private companies, similar to how hedge funds and mutual funds operate. However, private equity funds are typically managed by a single firm acting as the financial advisor, using the pooled money on behalf of the fund. Unlike mutual funds and hedge funds, private equity funds focus on long-term alternative investment opportunities.
Private equity includes both growth capital and venture capital. Venture capital targets early-stage startups, while growth capital focuses on more mature private companies. In addition to providing capital, private equity investors often offer additional guidance and expertise to their portfolio companies.
Private equity firms realize returns on their investments either by selling their shares in these companies or through the companies going public via an initial public offering (IPO).
Types of Private Equity Investments
Venture Capital: Venture capital firms invest in early-stage startups with high growth potential. These investments carry higher risk but offer the possibility of significant returns if the startup succeeds.
Buyouts: Private equity firms acquire controlling stakes in established companies, often with the goal of restructuring or improving operations to increase value before selling the company for a profit.
Private Equity Funds: These funds pool capital from investors to make investments in private companies across various sectors and stages of development.
Pros:
High Returns: Private equity investments have the potential for substantial returns, especially in successful startups or companies undergoing transformation.
Active Management: Private equity investors often take an active role in the management of portfolio companies, implementing strategic initiatives to drive growth and profitability.
Long-Term Horizon: Private equity investments typically have a longer investment horizon, allowing for patient capital to support growth initiatives.
Cons:
Lack of Liquidity: Private equity investments are highly illiquid, with limited opportunities to sell or exit investments until a liquidity event such as an IPO or acquisition occurs.
High Fees: Private equity funds charge management fees and performance fees, which can significantly reduce overall returns.
Risk of Failure: Investing in startups and distressed companies carries a high risk of failure, and not all investments will generate positive returns.
Hedge Funds
Hedge funds are pooled investment funds that utilize sophisticated tax structures and trading strategies. Hedge fund managers often employ short-selling, derivatives, and leverage to enhance the fund’s performance.
Unlike venture capital firms, hedge funds typically invest in highly liquid assets such as public equities, aiming to achieve the highest possible returns among alternative investments in the shortest timeframe. Hedge funds are primarily available to institutional investors, such as endowments and mutual funds, as well as high-net-worth individual investors who have a relatively high-risk tolerance.
Types of Hedge Funds
Long-Short Equity: Hedge funds take long positions in undervalued securities and short positions in overvalued securities to generate returns regardless of market direction.
Global Macro: Global macro funds invest based on macroeconomic trends and geopolitical events, including currencies, interest rates, and commodities.
Event-Driven: Event-driven funds seek to profit from corporate events such as mergers, acquisitions, bankruptcies, or regulatory changes.
Pros:
Diversification: Hedge funds employ a wide range of investment strategies and asset classes, providing diversification benefits to a portfolio.
Absolute Returns: Hedge funds aim to generate positive returns regardless of market conditions, offering potential downside protection during market downturns.
Risk Management: Hedge funds often use hedging techniques to mitigate downside risk and protect capital during volatile market environments.
Cons:
High Fees: Hedge funds typically charge management fees, performance fees, and sometimes additional expenses, which can erode returns, especially in periods of underperformance.
Limited Liquidity: Hedge funds often have lock-up periods and redemption restrictions, limiting investors’ ability to access their capital on short notice.
Complexity: Hedge fund strategies can be complex and opaque, requiring a deep understanding of the underlying investments and risks involved.
These are just a few examples of alternative investments, each with its own unique characteristics, benefits, and risks. When considering alternative investments, it’s essential to conduct thorough due diligence, assess your risk tolerance, and consider how each investment fits within your overall financial objectives and portfolio strategy.
Commodities
Commodities include tangible assets and natural resources such as oil, precious metals, land, and agricultural products. Investments in natural gas and oil usually have the potential for significant returns, but are typically accessible only to the wealthiest investors and large funds.
Other investors can generate returns by investing in forests and agriculture, which depend on trends in the timber industry and agricultural commodity prices. Collectibles, another subclass of tangible assets, deserve special attention due to their diversity and unique characteristics.
Types of Commodity Investments
Precious Metals: Gold, silver, platinum, and palladium are commonly traded precious metals. They are often used as stores of value and hedges against inflation and currency depreciation.
Energy: Crude oil, natural gas, and gasoline are major energy commodities. Energy prices are influenced by geopolitical events, supply-demand dynamics, and weather patterns.
Agricultural: Agricultural commodities include grains (e.g., wheat, corn, soybeans), livestock (e.g., cattle, hogs), and soft commodities (e.g., coffee, cocoa, sugar).
Pros:
Inflation Hedge: Commodities, especially precious metals, have historically served as hedges against inflation, preserving purchasing power during periods of currency devaluation.
Diversification: Commodities have a low correlation with traditional asset classes like stocks and bonds, providing diversification benefits to a portfolio.
Supply-Demand Dynamics: Commodity prices are influenced by global supply-demand dynamics, making them less susceptible to economic factors affecting traditional assets.
Cons:
Volatility: Commodity prices can be highly volatile due to factors such as geopolitical events, weather conditions, and changes in global demand.
Lack of Yield: Unlike stocks or bonds, commodities do not generate income such as dividends or interest, making them primarily reliant on price appreciation for returns.
Storage and Transportation Costs: Investing in physical commodities may entail costs related to storage, transportation, and insurance, which can erode returns.
Private Debt
Private credit, or private debt, refers to loans provided by entities other than banks. These lenders can be private debt funds specializing in this type of lending, as well as other companies and accredited investors capable of offering loans.
The “private” aspect pertains to the lender not being a bank, rather than the borrower. As a result, both private and public companies can benefit from this type of lending. Lenders generate returns on investment through the interest payments they receive.
Types of Private Debt
Direct Lending: Private debt funds or investors provide loans directly to companies, often in situations where traditional bank financing is unavailable or too costly.
Mezzanine Financing: Mezzanine debt sits between senior secured debt and equity in the capital structure and typically carries higher interest rates and additional risk.
Distressed Debt: Investing in the debt of financially distressed companies, often with the expectation of restructuring or bankruptcy proceedings.
Pros:
Steady Income: Private debt investments can provide consistent income streams in the form of interest payments, offering stable cash flow to investors.
Diversification: Private debt has a low correlation with traditional assets, providing diversification benefits to a portfolio.
Seniority: In the event of default or bankruptcy, private debt holders often have seniority over equity holders, providing downside protection.
Cons:
Credit Risk: Private debt investments carry credit risk, including the risk of default or bankruptcy by the borrower, which can result in loss of principal and interest.
Illiquidity: Private debt investments are often illiquid, with limited opportunities to sell or exit positions before maturity.
Market Timing: Investing in distressed debt requires expertise in assessing the timing and likelihood of a company’s recovery, which can be challenging to predict accurately.
Collectibles
Collectible items are tangible alternative investments acquired with the informed expectation that their value will appreciate over time. Some well-known collectible items that have been successfully used in alternative investment strategies include Pieces of art, Wine, Comic books, Rare antiques, Vintage cars, Stamps, and Rare coins.
Examples of Collectibles
Art: Paintings, sculptures, and other forms of fine art can appreciate in value over time, driven by factors such as artistic significance, historical context, and scarcity.
Wine: Fine wine from reputable producers and vintages can appreciate in value as they age, driven by factors such as provenance, condition, and critical acclaim.
Rare Coins: Collectible coins, especially those with historical significance or limited mintage, can appreciate in value due to numismatic interest and rarity.
This list is continually evolving and can expand based on cultural trends. For instance, sneakers have recently emerged as investment-worthy collectibles. It’s worth noting that investing in collectibles requires expertise in specific fields and the ability to preserve the items in excellent condition over many years.
Pros:
Potential for Capital Appreciation: Collectibles can appreciate in value over time, driven by factors such as scarcity, demand from collectors, and historical significance.
Tangible Asset: Collectibles offer tangible ownership, providing aesthetic enjoyment and the potential for diversification outside of financial markets.
Passion Investment: Collectibles can appeal to investors who have a passion for art, wine, or numismatics, making them an enjoyable and potentially profitable hobby.
Cons:
Subjective Valuation: Valuing collectibles can be subjective and influenced by factors such as market sentiment, artistic trends, and individual preferences.
Illiquidity: Selling collectibles may take time and effort, especially for items with niche appeal or high-value transactions that require expertise and authentication.
Storage and Maintenance Costs: Collectibles may require specialized storage conditions and insurance coverage to protect against damage, theft, or deterioration.
Cryptocurrencies
Cryptocurrency has likely garnered the most attention from the general public in recent years. It is more accessible to lay investors than most other assets on this list.
Cryptocurrency investment also tend to be quite liquid, as converting crypto to cash is straightforward. There are numerous diverse crypto options to invest in, although it is estimated that 90% of the market is concentrated among the top 20 cryptocurrencies.
However, the cryptocurrency market is highly volatile, difficult to predict, and plagued by scams and scandals. Therefore, investors should be aware of these risks before committing significant portions of their budget to cryptocurrency.
Examples of Crypto Investments:
Bitcoin (BTC): The first and most well-known cryptocurrency, Bitcoin operates on a decentralized blockchain and is used primarily as a store of value and medium of exchange.
Ethereum (ETH): Ethereum is a decentralized platform that enables smart contracts and decentralized applications (DApps), with its native cryptocurrency, Ether, serving as a fuel for transactions.
Altcoins: Alternative cryptocurrencies, or altcoins, include a wide range of digital assets with diverse use cases, such as privacy coins (e.g., Monero), stablecoins (e.g., Tether), and utility tokens (e.g., Binance Coin).
Pros:
Decentralization: Cryptocurrencies operate on decentralized blockchain networks, providing transparency, censorship resistance, and financial sovereignty to users.
Potential for High Returns: Cryptocurrencies have exhibited significant price volatility, offering the potential for high returns for early adopters and savvy investors.
Diversification: Cryptocurrencies have a low correlation with traditional assets, providing diversification benefits to a portfolio.
Cons:
Volatility: Cryptocurrency prices can be highly volatile, subject to factors such as market sentiment, regulatory developments, and technological advancements.
Regulatory Uncertainty: Cryptocurrencies face regulatory scrutiny and uncertainty in many jurisdictions, which can impact market liquidity and investor confidence.
Security Risks: Cryptocurrency investments are susceptible to hacking, fraud, and operational risks associated with exchanges, wallets, and smart contracts.
Each of these alternative investments offers unique opportunities and challenges, and you should carefully consider your risk tolerance, investment objectives, and time horizon before allocating capital to them. Diversification across multiple alternative investments and traditional assets can help mitigate risk and enhance long-term portfolio performance.
How to Find Alternative Investment Opportunities
Finding alternative investment opportunities can be challenging due to the opaque nature of many private markets. To overcome this, you should consider actively engaging with alternative markets and seek reliable sources of information. Here are some strategies to help you find and evaluate alternative investments:
Publicly Available Web Data
For alternative investments, research and data analytics is vital. Accessing and analyzing public web data can unveil investment opportunities in otherwise opaque private markets.
Real Estate, Private Equity, and Hedge Funds: These investments can benefit greatly from leveraging relevant data. For instance, venture capital firms can use startup data to identify promising early-stage companies. They can also analyze company funding data to assess the financial health of various startups.
Firmographic and Technographic Data: These types of data are valuable for private equity investing and any strategy involving investments in private firms.
Corporate Jet Tracking: Tracking the movements of corporate jets can provide insights into potential deals, leading to profitable decisions. However, caution is advised as this data can also lead to speculation.
Satellite Imagery and Geolocation: In real estate investing, satellite imagery and geolocation data can reveal trends in specific areas, providing valuable investment insights.
Financial Advisors for Alternative Investments
Traditional and alternative investments differ significantly, so experience in traditional markets doesn’t guarantee success in alternative ones. When starting out, it’s always wise to seek guidance from an expert in the specific field. Many consultancy firms and accredited investors specialize in alternative markets and can serve as financial advisors.
In some cases, getting an accreditation on specific fields or consulting with an expert is crucial for identifying the best opportunities. For example, profitable trading in art and paintings requires a good understanding of art and current trends in the art world. Even with this knowledge, it’s advisable to employ professional consultants when making evaluations.
How to Invest in Alternative Assets
Investing in alternative assets depends largely on your financial situation and qualifications. Here are several pathways to consider:
Accreditation
Many alternative investments require substantial capital and accreditation. Accredited investors gain privileged access to opportunities such as angel investments, venture capital, and hedge funds. Another route to accreditation is being part of a firm where accredited investors hold equity. Such an entity is considered an accredited investor, allowing you to access alternative investments through it.
Mutual Funds and ETFs
For those without accreditation, mutual funds and ETFs offer a way to invest in alternative assets. However, the investment cost can still be a barrier for many. Check out our list of the best investing apps to learn more.
Cryptocurrency and Collectibles
Investing in cryptocurrency and potentially valuable collectibles is more accessible. However, evaluating the potential of these assets is challenging, increasing the associated risks.
The Takeaway
Investing in alternative assets can deliver good returns for you if you do it right. Most alternative investments aren’t correlated with the conventional stock market returns, which should give you more flexibility and respectable returns overall.
You can start your journey into alternative assets by putting your money into a fund, acquiring assets on your own, or teaming up with other investors. Still, you should consider your time horizon, liquidity needs, risk tolerance, and investing objectives before jumping in.
