Alternative Investment - Types of Funds & Examples
Alternative Investment - Types of Funds & Examples
When you talk about investments, one of the first things that come to mind is stocks and bonds. While they are great investment vehicles and popular, they are highly volatile investments, and that's where alternative investments come in.
Alternative investments serve as a haven for i nvestors against the volatility of the public market. Typically, these investments are not regular investments but are essential for a balanced investment portfolio. This article will explain alternative investments and provide a complete guide for you as a new investor to facilitate the best decisions.
What is an Alternative Investment?
Simply put, an alternative investment is an investment that does not fall into the category of conventional investments such as stocks, bonds, and cash. An alternative investment will therefore include financial assets like hedge funds , private equity , venture capital, commodities, and collectibles. Real estate can also fit into the classification of alternative investments.
For many retail investors, alternative investments serve as the perfect tool for portfolio diversification since they have a lower correlation to traditional investments. For others, the potential for high returns is the catch. Though, just as every other investment is risky, this investment carries some risks.
Who Can Invest in Alternative Investments /Private Markets?
Usually come with a larger amount and a longer lock-up period, alternative investments have a unique risk profile that not every investor may be comfortable with. That explains why Hong Kong's Securities and Futures Commission (SFC) permits only a certain type of investors to access alternative investments. These investors are c lassified as professional investors; investors who fulfill certain income and net-worth criteria.
According to SFC, professional investors include:
- an individual having a portfolio of liquid assets (including but not limited to cash, deposits, securities) more than HKD 8 million at the date of registration.
- a trust corporation having been entrusted under one or more trusts with total assets of not less than HKD 40 million at the date of registration;
- For more information in detail: https://www.altive.com/en/professional-investor-notice
Key Characteristics: Traditional Vs. Alternative Investments
Other Alternative Investments
Fund of Funds
- Investment funds that invest in other types of funds rather than investing directly in assets
Natural Resources / Commodities
- Nature's valuables such as gas, oil, precious metals, and agricultural products
- Excellent risk hedge investments as they are not susceptible to the public equity market
Collectibles
- Physical assets that have the potential for returns through capital appreciation. Examples are wine, art, stamps, etc
Structured Products
- Investments whose value is dependent on other assets such as collateralized debt obligations (CDO), credit default swaps (CDS) and dividend-paying investments like government bonds
Real Estate
- Physical properties like land and houses, or investing in real estate funds
- One of the most liquid alternative investments
Types of Alternative Investments
There are different types of alternative investments, ranging from hedge funds to private equity, venture capital funds, private debts, etc. Let's x-ray the various types of alternative investments for better understanding.
Private Market Investments
Private Equity
Private equity is the share of a privately owned company. Not like stocks in the public market private equity cannot be publicly traded. With less transparent information and much larger ticket size of over US $10 billion per ticket, investors of private equity are usually limited to sovereign funds, insurance companies and mega tycoons. However, as many of these private companies are at their growth stage before going listed in the public market, private equity investment has the most potential to capture most of the growth of a company.
Of course, there’s a high chance for a start-up to fail especially at their early stage, so the earlier investing in a private company comes with a higher risk of the investment going in vain, but at the same time, more potential to grow. That’s why many private equity investors put their focus on later-stage start-ups, or what people usually refer to as ‘unicorn start-ups’, which means private companies valued at or over $1 billion and are very likely to succeed.
Private Credit/Debt
Private credit or debt is a non-bank loan and is also not traded on the public market. It provides a means for credit investors and companies to borrow and grow their businesses, this kind of direct lendings are commonly first-lien loans which have the first claim on collateral. Private credit/debt tends to be floating rate, it is one of the most popular products during a rising rate environment.
Private REITs
Private REITs are real estate funds that are not listed on public exchanges and can provide retail investors access to a portfolio of hardly accessible real estate investments such as landmark buildings, infrastructures, data centers, residential buildings, etc. Historically private REITs are served as a hedge against inflation over the long term as the growth in rents is highly correlated with inflation.
Hedge Funds
Hedge funds are collective investments targeted at earning high returns on investment. They invest in a myriad of assets and often take very risky approaches to investment in an attempt to attain their goal.
Due to the high risk involved in hedge funds, it is usually advised for institutional investors or high-net-worth individual investors with high-risk levels.
Venture Capital Funds
Venture capital funds refer to pooled investment funds to provide capital for startups in exchange for a stake in the company. They look out for startups that have strong growth potential and invest in them to make a fortune in the later years.
Venture capital takes an active part in the management of these startups and monitors them closely to ensure their growth. Once the firm is publicly traded or acquired, venture capital
Fund of Funds
- Investment funds that invest in other types of funds rather than investing directly in assets
Natural Resources / Commodities
- Nature's valuables such as gas, oil, precious metals, and agricultural products
- Excellent risk hedge investments as they are not susceptible to the public equity market
Collectibles
- Physical assets that have the potential for returns through capital appreciation. Examples are wine, art, stamps, etc
Structured Products
- Investments whose value is dependent on other assets such as collateralized debt obligations (CDO), credit default swaps (CDS) and dividend-paying investments like government bonds
Real Estate
- Physical properties like land and houses, or investing in real estate funds
- One of the most liquid alternative investments
Benefits of Alternative Investments
Low Correlation
One of the best benefits investors stand to gain with alternative investments is the low correlation to traditional assets. This simply means that the negative performance of traditional assets such as stocks does not directly impact alternative investments .
Diversification
Alternative investment offers investors greater portfolio diversification. Due to its low correlation, investors can allocate some of their money there and stand a chance to gain even when the equity market is not doing well.
Inflation Hedge
Alternative investments can be an excellent wa y to hedge against inflation. Gold, for instance, increases in value even with currency devaluation. Hence, it becomes a good store of value. Commodity futures can also be an instrument to secure value against future volatility.
Lower Volatility
Market volatility has minimal impact on alternative assets due to less exposure to the equity market.
Potentially high Return
Depending on the strength of management, alternative investments offer the potential for a better return on investment. Historically, the low liquidity features of it have produced a liquidity premium as an equivalent return.
Risks of Alternative Investments
Risks involved in alternative investments include:
Relatively Higher-Risk Investment
Alternative investments present investors with opportunities for high returns, but also comes with a larger investment amount to commit and lower liquidity.
Some alternative investment products such as hedge funds, deploy investment strategies such as volatility arbitrage, long-short equity, which potentially come with a higher risk.
Low Liquidity
Alternative investments cannot be easily converted to cash since they are not traded on public exchanges. And, unlike stock an investor can choose to sell their investment anytime, some alternative investments are fixed for a specific period.
High Minimum Investments
Alternative investments require a high minimum investment, traditionally requiring millions of US. It sets barriers for many investors to step in.
Difficulty in Valuation
One major challenge with alternative investment is valuation. Since they are not listed on the market, the information is not as transparent, deriving the actual value of an alternative investment can be difficult.
Other Alternative Investments
Fund of Funds
- Investment funds that invest in other types of funds rather than investing directly in assets
Natural Resources / Commodities
- Nature's valuables such as gas, oil, precious metals, and agricultural products
- Excellent risk hedge investments as they are not susceptible to the public equity market
Collectibles
- Physical assets that have the potential for returns through capital appreciation. Examples are wine, art, stamps, etc
Structured Products
- Investments whose value is dependent on other assets such as collateralized debt obligations (CDO), credit default swaps (CDS) and dividend-paying investments like government bonds
Real Estate
- Physical properties like land and houses, or investing in real estate funds
- One of the most liquid alternative investments
How to Invest in Alternative Investments / Private Markets
Due to a large ticket size up to over US $10billion per ticket, less transparent information and relatively low liquidity, individual investors could hardly invest in the private markets. But with the technology empowerment nowadays, there are alternative investment platforms that have removed the barrier of the large ticket size and are providing more transparency to the private markets.
For instance, Altive offers top-tier private market investment opportunities to professional investors from US $10k per ticket. Using the feeder fund structure together with the A.I. technology that enables the eKYC process to light speed, Altive is able to collect the small tickets from individual professional investors and open up all the opportunities that alternative investment has to offer.
Regulation of Alternative Investments
Generally, the establishment of alternative investment funds (AIFs) in Hong Kong takes three forms: companies, limited partnerships, and unit trusts. The Securities and Futures Ordinance (SFO) is the primary legislation that governs the operation of AIFs. The SFC, as a statutory body, is governed by the SFO and handles the administration of the securities and futures markets in Hong Kong.
Hence, every alternative investment fund operating in Hong Kong must be licensed, authorized, and regulated by the SFC. As such before investing in alternative investments , the investor should have done extensive due diligence to ensure the investment has a legal structure.
FAQs
#1. Are alternatives riskier than stocks and bonds?
Unlike stocks and bonds that you may trade daily, alternatives usually come with a lower liquidity that could take over 5 years. Also, alternatives usually come with a larger amount of minimum investment. Some may consider alternatives are riskier in terms of liquidity and large investment amount. But in return, it offers a more attractive liquidity premium and lower volatility. So many investors are allocating alternatives into their portfolios in order to diversify their investment risks.
#2. How much should you invest in alternatives?
Alternatives are new to many investors, hence it's advisable to start with a a lower quantity of your portfolio. It is recommended to start from 10-20% and gradually increase to 50% or above of your portfolio.
#3. Is Cryptocurrency an alternative investment ?
Blockchain-empowered investment products, including cryptocurrencies and NFTs, are getting wider acceptance as alternative investments .
Cryptocurrency investment, when compared to traditional investments, provides high return potential and higher volatility, and therefore higher risks, so ensure to investigate the risk involved in cryptocurrency investment before committing your money.
“How to Invest in Alternative Investments/ Private Markets”
More to read:
A Complete Guide To Private Equity Investment
Private Markets VS Public Market: Difference and Examples
Source: