An introduction to alternative investing

QuietGrowth - An introduction to alternative investing

Alternative investing refers to investments outside traditional stock, bond, and cash holdings. The goal of alternative investing is to provide diversification and attempt potentially higher returns compared to traditional investments.

However, most come with higher risks and may be subject to different regulations and restrictions. They can also be complex and may have limited liquidity, which means it can be challenging to sell the investment quickly and may be subject to restrictions on transfer or resale. Additionally, most alternative investments may have higher fees and may require significant minimum investments, making them less accessible to individual investors.

These types of investments may not be suitable for all investors, and it is important to carefully consider one’s investment goals, risk tolerance, and investment time horizon before deciding to invest in alternative assets.

Different types of alternative investing

There are many different types of alternative investing, including:

  • Real estate: Direct investment in residential, commercial, or industrial properties for rental income and potential capital appreciation. These are usually less liquid.
  • Private equity: Investment in privately held companies, usually through purchasing shares in a private investment fund. These are usually less liquid.
  • Hedge funds: Investment funds that employ various risky strategies, including leveraging, derivatives and short selling, to attempt better returns. Some of these are less liquid.
  • Venture capital: Investment in venture capital funds or directly in startups. These are less liquid.
  • Small businesses: Investment in private small businesses. These are usually less liquid.
  • Commodities: Investment in physical commodities such as gold, silver, oil, or agricultural products. These are liquid if the underlying commodities are securitised.
  • Art and collectibles: Investment in works of art, antiques, rare coins, stamps, or other collectibles. These are less liquid.
  • Infrastructure: Investment in physical infrastructure assets such as roads, pipelines, bridges, airports and power plants. These are less liquid.
  • Cryptocurrencies: Investment in digital currencies, such as Bitcoin or Ethereum, that operate independently of a central bank. These are liquid.
  • Wine: Investment in high-value wine bottles with the intention to not consume them. These are less liquid.
  • Agricultural land: Investment in farmland for the purpose of generating rental income or producing crops. These are less liquid.

History of alternative investing

The history of alternative investments goes back to the early days of finance when wealthy individuals and institutions sought to diversify their portfolios beyond traditional stocks and bonds. For example, investment in fine art and collectibles has a long history, with records of art being traded as an asset dating back to ancient civilisations.

The modern concept of alternative investments as a separate category of assets emerged in the late 20th century as new types of investments became available and more widely adopted. The rise of private equity, hedge funds, venture capital and other alternative investment vehicles was driven by several factors, including regulation changes, technological advances, and a growing demand for more diverse investment opportunities.

The earliest alternative funds typically focused on a narrow range of alternative investments, such as real estate or commodities. Then as the field evolved, alternative funds began to offer exposure to a broader range of alternative assets. As more investors began to seek exposure to alternative investments, fund managers responded by creating new funds that provided access to these assets.

One of the key developments in the history of alternative funds was the advent of hedge funds, which allowed investors to gain exposure to a wide range of alternative investments through a single, professionally managed vehicle. Over time, hedge funds became increasingly popular, and by the late 20th century, hedge funds had become a sizeable player in the global financial landscape.

In the last few decades, alternative investments have become increasingly important in the global financial landscape. Today, alternative investments are popular among investors seeking to diversify their portfolios, attempt to generate higher returns or gain exposure to new and unique investment opportunities. However, despite their growing popularity, some alternative investments remain a complex and often misunderstood area of finance, and investors must perform due diligence carefully.

Risk of alternative investments compared to stocks and bonds

Not all alternative investments carry the same level of risk. For example, some alternative investments, such as real estate or infrastructure, may be relatively stable and generate relatively predictable income. In contrast, others, such as hedge funds or commodities, may be more volatile and subject to sudden changes in market conditions.

It’s also worth noting that the potential for higher returns often offsets the risk associated with alternative investments. Therefore, when considering alternative investments, it’s crucial to research the specific investment thoroughly and to understand the potential risks and rewards.

Net worth of an individual to gain access to alternative investments

The net worth required to gain access to alternative investments varies depending on the specific investment and the requirements of the fund or platform offering access to these investments. For example, some alternative investments, such as hedge funds or private equity, may have minimum investment requirements of several hundred thousand dollars or more. In contrast, others, such as ETFs that invest in alternative assets, REITs and bitcoin, have much lower minimum investment requirements.

Generally, the higher the minimum investment requirement for an alternative investment, the more exclusive and less accessible the investment is likely to be. High-net-worth individuals and institutional investors are typically the primary target market for alternative investments because they tend to have the financial resources and risk tolerance necessary to invest in these assets.

Proportion of portfolio in alternative investments

Typically, high-net-worth individuals will allocate a portion of their portfolios to alternative investments to diversify their holdings and potentially generate higher returns.

Many financial advisers suggest that a well-diversified portfolio should have between 5% and 10% invested in alternative investments. However, this is just a rough estimate, and the exact portfolio mix will depend on an individual’s specific financial circumstances and investment goals.

Alternative investments and play money

Not all alternative investments of a person need to be part of his play money.

For example, some alternative investments such as real estate and gold commodity are less risky than public stocks and hence cannot be considered as play money. In contrast, some other alternative investments such as venture capital and hedge funds are riskier than public stocks and hence can be considered as play money.

Alternative investments as part of the satellite portion of core-satellite investing

The satellite portion of a core-satellite portfolio can contain alternative investments. Alternately, there can be two satellites, one for illiquid alternative assets and the other for liquid alternative assets.

We also observe that some liquid alternative investments, such as REITs and gold ETFs, are included in the core portion of a core-satellite portfolio.

Alternative investing and long-term investing approach

Alternative investing can be either short-term, mid-term or long-term oriented, depending on the specific investment and the investment strategy.

Some alternative investments, such as private equity, direct real estate, and venture capital, are often considered long-term investments as they typically involve significant time horizons and may require patience to realise returns. These investments may involve a longer holding period and may require a significant capital commitment.

Other alternative investments, such as hedge funds and commodities, are often short term. These investments may be suitable for investors looking for more immediate returns and willing to accept the associated risks.

Ultimately, the investment horizon for alternative investments will depend on the individual’s specific investment goals and risk tolerance, as well as the specifics of the asset itself.

Our view at QuietGrowth

To know about our view at QuietGrowth regarding alternative investing, refer to the ‘Hedge funds‘, ‘Private equity funds‘, ‘Private companies and startups‘, ‘Cryptocurrencies‘, ‘Non-fungible tokens‘, ‘Digital assets in the metaverse‘ sections in our Investment Methodology page.

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