Alternative investments are becoming increasingly popular for investors looking to diversify their portfolios beyond just stocks and bonds. However, many alternative assets can be complex and difficult to evaluate. This article provides a comprehensive guide to the major types of alternative investments, their risks and returns, and factors to consider before investing. With the key information provided here, investors will have a solid foundation for evaluating if alternative investments have a place in their portfolio. There will be detailed discussions of alternatives like private equity, venture capital, hedge funds, managed futures, real estate, commodities, and more. By the end, readers will understand the landscape of alternative investments and be equipped to determine if they are suitable for their individual financial situations and investment goals.
Private equity and venture capital provide exposure to young companies with high growth potential
Many alternative investments provide exposure to private companies that offer the chance for above average growth in exchange for higher risks. Private equity involves investing in more established private companies, while venture capital focuses on providing seed funding for startups and small businesses with innovative ideas. While they can produce high returns, there is also substantial risk of loss as many young companies fail. Extensive due diligence is required to identify well-managed companies with strong business models in growing industries. Investors need to understand these are long-term, illiquid investments that may take 5-7 years to pay off.
Hedge funds aim to generate market-beating returns through flexible investment strategies
Hedge funds are actively managed alternative investments that utilize a wide range of sophisticated trading strategies to try generating strong risk-adjusted returns. They might invest in stocks, bonds, derivatives, currencies, and more. Common strategies include long/short equity, event-driven, global macro, relative value, and more. The flexibility allows them to profit in both rising and falling markets. However, hedge fund returns are often correlated to stock markets and the high fees can eat into profits. Investors should understand their strategies and liquidity terms before investing.
Managed futures funds provide portfolio diversification through trading of futures contracts
Managed futures funds allow investors to access returns from the global commodity and financial futures markets. Professional money managers execute trades across assets like energies, metals, agricultural goods, currencies, stocks indexes, and bonds. The trading is guided by algorithmic models and risk management strategies. The low correlation to stock and bond markets means managed futures can enhance diversification. However, the complex trading strategies involve significant risks as well. These investments are better suited for larger institutional investors rather than individual investors.
Real estate investment trusts offer exposure to commercial and residential real estate
Real estate investment trusts (REITs) allow investors to gain exposure to real estate without having to buy, manage, and finance properties directly. REITs own and operate real estate and trade on major stock exchanges. Some focus on leasing commercial properties like office buildings, malls, and warehouses. Others specialize in owning residential rental apartments. Investors can gain diversification and income from REIT dividends. However, changes in the economy, interest rates, and real estate market can create volatility. REITs also carry liquidity and management risks like other alternative investments.
Commodities and natural resources provide an inflation hedge but add portfolio volatility
Investing in commodities and natural resources like precious metals, oil, natural gas, lumber, agriculture, and more can hedge against inflationary environments. Commodity prices tend to rise with inflation. Gaining exposure through commodity futures contracts, ETFs, mutual funds, or companies that produce commodities allows benefiting from price appreciation. However, commodities tend to be extremely volatile, exhibit boom and bust cycles, and have high storage and insurance costs. Most investors are best served with only a small allocation to commodities for diversification and as a hedge against inflation or geopolitical crises.
Alternative investments encompass a broad range of assets beyond just stocks and bonds. While they can enhance portfolio diversification and returns, they also come with larger risks and liquidity constraints. Investors must carefully assess if the potential benefits outweigh the higher costs and risks for their personal situations. With education and prudent allocations, alternative investments can play a role in a balanced portfolio.