Alternative Investments

November 23, 2010Asset Managementby EconomyWatch

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The most common instruments in which people invest are stocks, bonds and forex. However, exposure to these limited investment options raises the risk profile. Portfolio diversification, or holding assets with different characteristics, is an effective way of reducing the risk exposure for the same level of profit potential. Portfolio diversification can be achieved through alternative investments. Investments made into assets that do not fall under one of the three traditional asset types (cash, stocks and bonds) are called alternative investments.

Alternative Investments: Types

Alternate investments usually require high minimum capital. Moreover, investments in these alternative avenues are less regulated. The most common alternative investments are:

  • Futures: Futures are standardized contracts for the sale and purchase of a commodity on a specified date and at a predetermined price. Futures can be used to trade currencies and commodities (such as oil and agro products). People can also invest in S&P and NASDAQ futures.
  • Options: Options are similar to futures. The only difference is that the holder of an options contract is under no obligation to buy or sell the underlying asset. S/he can just let the contract expire.

 

  • ETFs: Exchange traded funds (ETFs) hold assets such as stocks, bonds, commodities and precious metals. These ETFs are traded on the stock exchange at a price that equals the net asset value (NAV) of the underlying asset. The most common ETFs used as alternative investments are gold and oil.
  • Hedged funds: Hedge funds invest in a broad range of investment options, including stocks, debt and commodities. They often aim at offsetting potential losses in the markets they invest in. They use methods, such as short selling, to hedge their investments.
  • Real estate: This investment option involves buying and selling immovable property, such as land and buildings. This investmentyields rental income as well as capital appreciation.
  • Art: The popularity of art as an alternative investment rose significantly following the financial crisis of 2008 due to a prolonged downturn in the stock market, a slowdown in the economy and low interest rates.
  • Gold: Gold is a defensive investment and becomes more popular during periods of prolonged economic and political upheavals.
  • Wine investment: Investments in fine wine have yielded healthy returns over the past few years. Wine investments also remained relatively insulated from the 2007-2008 credit crunch.

Benefits of Alternative Investments

Alternative investments:

  • Diversify an investor’s portfolio.
  • Reduce risks.
  • Offer good profit generating opportunities.

Drawbacks of Alternative Investments

The limitations of alternative investments are:

  • The liquidity of these investments is lower than that of stocks, bonds and cash.
  • The fee structures for these investments are generally higher than those for stocks and bonds.
  • These investments require specific expertise, as a result of which the costs associated with due diligence are high.
  • It is difficult to establish benchmarks for these investments. This hinders the performance appraisal of the investmentsMoreover, the lack of performance data limits an investor’s ability to make an informed choice.

Further Resources

Investment firms such as Goldentree Asset Management and other reputable agencies have different trading advisories so you can learn which strategy works best on your funds.