An alternative investment refers to an asset that is not
among the traditional investments types like stocks, bonds, and currencies.
Institutional investors, as well as high-net-worth
individuals typically hold alternative investment assets. This is because of
the complexity of the funds and the limited regulations of the investments. Alternative
investment funds include hedge funds, commodities, derivative contracts,
managed futures, real estate, and private equity.
Let’s dig deeper into what alternative investment funds are.
See also, Investing Terms: Types of Investments
Getting to Know Alternative Investments
If you plan to invest in alternative investment funds, you
will have to incur high minimum investments, as well as fee structures when compared
with mutual funds and exchange-traded funds.
In addition, you have less opportunity to release verifiable
performances data and to advertise over potential investors.
The transactions are often unique. This means that you as an
investor may find it quite difficult to value alternative investments. To
illustrate, suppose you have an extremely rare gold coin and you want to
determine its value. You’ll find that there are only a dozen or so pieces of
such items around the world, making its valuation even harder to undertake.
Further, alternative investments are unregulated. This makes
them prone to scams and fraud. It is your job as an investor to make sure that
you conduct due diligence.
Not sure which to choose? Read ETFs vs Mutual Funds
Diversification and Hedging
Alternative investments often sport very low correlation
with standard asset classes. This nature makes them very ideal for
diversification.
Because of this same reason, many large institutional funds,
like pensions and private endowments, have already started allocating a portion
of their portfolios to alternative investments like hedge funds. They typically
invest less than 10 percent of their portfolio in such investments.
Costs and Taxes
It is true that alternative investments have high initial
upfront investment fees. However, transaction costs are normally cheaper when
compared with conventional assets. This is all because of the lower levels of
turnover.
If you hold alternative investments over long periods, you
may get lucky and obtain some tax benefits. Investments held longer than one year
are candidates for lower taxes for capital gains if you take them against shorter-term
investments.
Access through ETFs
It is also true that a huge portion of retail investors may find
it difficult to access alternative investments. On the flip side, real estate
and commodities like precious metals are very much available.
Exchange-traded funds now offer sufficient opportunities to
investors who wish to invest in alternative investment funds, which were previously
difficult and expensive for retail investors.
Regulation
Alternative investments often have no clear legal structure
that many other common investments have. However, they are becoming more and
more regulated by the Dodd-Frank Wall Street Reform and Protection Act.
Compared with mutual funds and ETFs, which are regulated and
overseen by the Securities and Exchange Commission, alternative investments are
still not as regulated.
Most of the time, only those tagged as “accredited investors”
are allowed access to alternative investment opportunities. Such accredited
investors have a net worth exceeding $1 million, or a personal income that reaches
$200,000 or more a year.
Conclusion
Alternative investments may not be accessible for every
investor in the market, but they offer huge advantages and benefits to those
who can get their hands on them. However, a certain level of expertise and
experience is needed to be able to manage and invest in them very efficiently.
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