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These are non-traditional investments that are considered to be their own investment category and allow you to take a high-risk, high-reward approach to your portfolio. The alternative asset classes you can invest in include everything from hedge funds to real estate to private equity. Alternative investments can also take the form of venture capital funds. The following is a comprehensive guide on alternative investments for dummies.

What Is an Alternative Investment?

Alternative investments are essentially any type of financial asset that isn't a bond, stock, or cash. These non-traditional assets are usually less liquid, which means that they cannot be quickly converted into cash or sold. So, why invest in alternative investments? The reason is so that individual investors can diversify their portfolios effectively. 

When you're investing in alternatives and want to build a strong portfolio, you might want to use a strategy that focuses on non-correlated assets for true portfolio diversification.

The most common alternatives to invest in include:

  • Hedge funds
  • Commodities
  • Venture capital
  • Private equity 
  • Private debt
  • Real estate

Types of Alternative Investments

When you want to invest in alternatives, there are many different types of non-traditional investments you can make. Each type requires you to implement different alternative investment strategies and a risk-management approach to obtain high returns.  

Alternative Investments

1. Hedge Funds

Hedge funds are standard investment funds that involve trading somewhat liquid assets and employing various alternative investment strategies. Like all investment funds, assets from numerous investors are pooled together to allow for larger investments to be made. 

Hedge fund managers are skilled at employing many different types of strategies, which can include everything from long-short equity to volatility arbitrage. In most cases, these funds are only available to institutional investors. However, if you decide to invest in hedge funds, these funds can invest in commodities, which are described below. 

At e360 Power, the commodities investments we facilitate include power, natural gas, and emissions markets. 

2. Commodities

Commodities are unique investments that focus on real assets. The majority of commodities are natural resources. While there are many different types of commodities that you can invest in, the two primary types utilized here include power and natural gas, both of which are essential for homeowners and businesses across the world. Other commodities include agricultural products, industrial metals, and oil. 

These investments are oftentimes used as a hedge against inflationary conditions since they don't change in accordance with public equity markets. Keep in mind that the value of these commodities increases or decreases as a result of supply and demand. When demand is high, the value will increase. 

3. Venture Capital

Venture capital is a type of private equity that focuses specifically on investing in the growth phase of a startup company. When a company of any kind has just formed, there's no telling whether it will fail or succeed. By getting in on the ground floor, there's potential for extremely high returns. Venture capital firms raise funds from institutional investors or high-net-worth individuals. 

Once these funds have been collected, a venture capital firm can invest at different stages of a company's growth. To understand how beneficial these alternative investments can be, keep in mind that venture capital firms were involved in the early stages of Facebook, Twitter, and Google. 

4. Private Equity

Private equity is a relatively broad segment of alternative investments that involves all capital investments that are made into a private company. These companies include any business that isn't directly listed on the New York Stock Exchange or any other public exchange. The various types of private equity that you can invest in include growth capital, venture capital, and buyouts. 

Growth capital is designed to help older companies restructure or expand. On the other hand, buyouts occur when an entire company or at least one of its smaller divisions is acquired. When private equity companies invest in a company or firm, they typically offer more than money. Some of the benefits that private equity companies can deliver include mentorship, industry expertise, and help with talent sourcing.

5. Private Debt

Private debt is a type of alternative that isn't traded on the open market or financed by a bank. Despite its name, private debt can be borrowed by private and public companies alike. This form of debt is typically sought when a company requires extra capital to grow its business. 

Let's say that a company wants to expand to a new market. In this situation, the company could seek private debt to help with this growth and expansion. Companies that issue private debt are referred to as private debt funds. The returns from these investments come in the form of initial loan repayment as well as interest payments. 

6. Real Estate

Real estate is a highly varied alternative that allows investors to effectively customize their investment strategy. Investing in real estate can involve everything from buying an apartment complex to investing in a "fixer-upper" that you can renovate and eventually flip for high returns. Even though real estate is considered to be an alternative investment, it has characteristics that are similar to those of bonds. 

The purpose of a real estate investment is to increase the asset's value via capital appreciation. As such, returns are available in the form of equity. It's also possible to obtain returns by collecting rent payments. There are many types of valuation methods that can be used with these investments, which is something to be aware of before you begin investing in real estate. 

Investing in Alternatives vs. Traditional Investments

Before you decide which investment strategy is best for your portfolio, you should compare investing in alternatives vs. traditional investments. Non-traditional investments can be highly advantageous but also have disadvantages that you should be aware of.

Traditional Investments

Benefits of Alternative Investments

The primary benefits of alternative investments include:

  • Potential for high returns - Investing in alternatives can be highly advantageous because of the ability to earn high returns. If you are knowledgeable about the investments you're making and are willing to take on the higher risk, these investments have the potential for some of the highest returns.
  • Hedge against eventual inflation - Alternative investments tend to move in the opposite direction when compared to stocks and bonds. Since inflation tends to worsen the value of some stocks and bonds, your alternative investments can protect against losses.
  • Allows for portfolio diversification - Because alternative investments don't correlate well with the overall stock market, it's possible to diversify your investment portfolio with alternative investments.

Disadvantages of Alternative Investments

The issues you should be aware of when investing in alternatives include:

  • Difficult to source since there are limitations to a public offering.
  • Fee structures can vary.
  • Relatively high minimum investments - Many of these assets are only able to be held by high-net-worth individuals and institutional investors who have become accredited. Being accredited comes with a strict requirement of a $1 million net worth and at least $200,000 in income.
  • Less regulation - Alternative investments don't necessarily need to be registered with the SEC, which means that they are riskier than mutual funds.

How to Invest in Alternative Assets

Investing in alternative assets is simpler than it might seem at first glance. Even though a large number of alternative investments are only available to high-net-worth individuals or institutional investors, there are several non-traditional investments that non-accredited investors can take advantage of. For instance, ETFs and alternative mutual funds are oftentimes available to individual investors. 

Your investment will be pooled together with the money from other investors, which makes it possible to invest in high-cost alternatives. The main difference between these alternatives and others is that they are traded publicly, which means that they are also registered with the SEC. 

Busting Alternative Investment Myths

Since alternative investments aren't as common as traditional ones, numerous myths have been spread around. While it can take time to become acclimated to alternative investing, these investments can be highly beneficial for any portfolio. 

Alternative Investment Myths

Myth 1: Alternatives Have More Volatility than Bonds and Stocks

Alternatives aren't necessarily any more or less volatile than the stocks and bonds you can invest in. Many investors believe that non-traditional investments are more volatile because they are less understood. 

Myth 2: Alternatives are Considered a Single Asset Class

Alternative investments involve any type of investment that isn't a stock, bond, or cash, which makes them part of several different asset classes. 

Myth 3: Investing in a Single Alternative Fund Diversifies My Portfolio

Investing in alternative funds can help you diversify your portfolio. However, many potential investors have mistakenly believed that investing in a single alternative fund can diversify their portfolios. The truth is that it takes numerous investments to properly diversify any portfolio. 

Myth 4: Investors are Unable to Access their Money When Investing in Alternatives

Even though most alternative investments are illiquid, this doesn't mean that you can't gain access to the funds that you've earned. Some mutual funds may offer access to cash daily. Other investments range from 30 days to 10 years.

Myth 5: Alternatives were Unable to Protect Investors While Market Downturns were Ongoing

Even though alternatives can fall when market conditions are poor, historical trends show that they don't fall as far as stocks

Myth 6: Alternative Investments are Too Costly

Because alternative investments were once solely invested in by individuals with high amounts of assets, many people formed the belief that these investments cost a considerable sum of money. However, the investment structure can cause fees to vary significantly.

Diversify Your Portfolio with Alternative Investments

Alternative investments are the perfect way to diversify your portfolio. While many of these investments come with a relatively high amount of risk, they are varied enough to ensure that your portfolio takes on the exact amount of risk that you want it to. Whether you would like to invest in real estate or hedge funds, you should be able to find alternative investments that match your investment strategies and provide you with the returns you're looking for. Contact our team at e360 Power to find out how we can help you invest in alternatives.

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