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Alternative Investments

What Is an Alternative Investment?

An alternative investment is a financial asset that does not fall into one of the conventional investment categories. Conventional categories include stocks, bonds, and cash. Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk. Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.

KEY TAKEAWAYS

  • An alternative investment is a financial asset that does not fall into one of the conventional equity/income/cash categories.
  • Private equity or venture capital, hedge funds, real property, commodities, and tangible assets are all examples of alternative investments.
  • Most alternative investments are unregulated by the SEC.
  • Alternative investments tend to be somewhat illiquid.
  • While traditionally for institutional investors and accredited investors, alternative investments have become feasible to retail investors via alt funds, ETFs and mutual funds that build portfolios of alternative assets.

The Big List of Alternative Investments

  • Residential Real Estate
  • Commercial Real Estate
  • Industrial Real Estate
  • Tax Liens
  • Precious Metals Mineral Rights
  • Lease Options on Real Estate
  • Venture Capital/Angel Investing

Strategy for Alternative Investments

Alternative investments typically have a low correlation with those of standard asset classes. This low correlation means they often move counter—or the opposite—to the stock and bond markets. This feature makes them a suitable tool for portfolio diversification. Investments in hard assets, such as gold, oil, and real property, also provide an effective hedge against inflation, which hurts the purchasing power of paper money.

Because of this, many large institutional funds such as pension funds and private endowments often allocate a small portion of their portfolios—typically less than 10%—to alternative investments such as hedge funds.

The non-accredited retail investor also has access to alternative investments. Alternative mutual funds and exchange-traded funds—aka alt funds or liquid alts—are now available. These alt funds provide ample opportunity to invest in alternative asset categories, previously difficult and costly for the average individual to access. Because they are publicly traded, alt funds are SEC-registered and -regulated, specifically by the Investment Company Act of 1940.3.

PROS

  • Counterweight to conventional assets
  • Portfolio diversification
  • Inflation hedge
  • High rewards

CONS

  • Difficult to value
  • Illiquid
  • Unregulated
  • High-risk

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