What is an Alternative Asset?
The traditional asset types that most investors are used to dealing with include things like stocks, bonds, and cash. Alternative assets, on the other hand, are … well, something different. They’re true “alternatives” to the tried-and-true investable asset classes, and they are on the rise, increasingly impacting capital markets and mainstream business, according to the World Economic Forum.
Why? Because, in today’s global markets, it’s increasingly difficult to spread out your risk and find assets that aren’t on at least some level interconnected. Stocks in general move in lockstep with each other, driven by the popularity of index-tracking exchange-traded funds (ETFs) and mutual funds, and bonds are more often than not more closely tied to stock performance than they have been in the past.
Alternative assets, on the other hand, are a way to create a truly diversified portfolio. Some of them come with higher risk, but the possibility for a big return—like investing in the next Facebook. Others—like investments in blue-chip art via Masterworks—can help to protect against losses if the economy goes south.
Although an exciting way to diversify your investment portfolio, alternative investments also pose unique challenges of their own. Because of their unique nature, alternative investments tend to be less liquid than the stocks and bonds you might be used to trading via your brokerage’s website. After all, a bottle of investment-grade wine might be worth a lot of money, but finding a buyer who will pay you what it is worth might take more than the few clicks it takes to sell a stock. Also, proper valuation of alternative assets is less than cut and dry. It all comes down to the price you can get another investor to pay for what is a fairly unique asset.
And—particularly for venture capital, private equity buyouts, hedge funds— these assets do not typically adjust for inflation.
What Are Examples of Alternative Investments?
Here are some of the common options for investors interested in exploring alternative investments.
Private Equity: Many private companies take investor capital in order to help scale their businesses. Private equity funds raise that capital from investors and use it to invest in promising private companies that need help. These funds include venture capital that invests in start-ups at all stages of a private company’s growth. As an alternative asset, private equity funds are a choice investment of institutions, including pension funds, sovereign wealth funds and endowments, as well as high net worth individuals because of their attractive risk-adjusted returns relative to other asset classes.
Venture Capital: Directly investing in a start-up company, which is often known as seed capital or angel investing, is also a possibility for alternative investors. The appeal of early-stage startup investing is that it offers the potential for astronomical growth, along with the satisfaction that you’re supporting something that may one day change the world (just ask the early investors in Amazon or Apple). That said, direct investment in start-ups carries greater risk than most other investments, as it’s true that the majority of start-ups fail in their first few years and never return anything to investors. But, by spreading out your investments over a number of different start-up companies, savvy venture capital investors can spread out this risk and increase their chance of hitting on a successful company that returns many times their investment once they go public or are acquired. Again, these investments tend to come from institutional or high net worth individual investors.
Hedge Funds: Hedge funds are pooled investment funds in which a full-time manager invests the money that partners put into the fund into a wide range of different assets. This can include everything from public equities, to private companies, unique alternative investments, and more, all with the goal of growing the fund’s underlying capital while hedging the group from the risk of loss. Despite that, hedge funds do carry a greater risk than more traditional options, but also offer the possibility for larger returns. For this reason, and because of the high fees often associated with them, hedge funds tend to appeal to wealthier investors (and are generally only available to accredited investors at the very least).
Real Estate: The alternative asset that’s most accessible to retail investors, real estate offers the appeal of predictable returns in the form of rent, as well as steadily increasing equity as you pay into the property. Real estate investments also offer the appeal of long-term appreciation, hedging against inflation, as well as tax benefits.
Art and Other Collectibles: Art, rare coins, a fine bottle of wine, or other physical assets and commodities make up this group of alternative investments. These more exotic investments tend to attract investors with a personal interest and financial flexibility. While physical assets like gold tend to hedge a portfolio against inflation woes, proper valuation of more exotic tangibles can be tricky, as can finding the right buyer.
Art also has the added benefit of being entirely isolated from the public markets, so it is a noncorrelated asset that tends to appreciate over time no matter what happens with stocks and bonds. Masterworks can help you start investing in art for as little as $1,000. Ask us how!
When investing in alternative assets, your strategy should match your capital capacity, risk levels, and personal interests. They should also pair with more mainstream investments, like stocks and bonds.
But, if they are right for you, they can be the perfect addition to any portfolio.