Other Asset Classes

Most investors are familiar with the more traditional forms of investing, such as stocks and bonds. However, an increasing number of investors desire alternative assets with which to grow their money.

Most investors are familiar with the more traditional forms of investing, such as stocks and bonds. However, an increasing number of investors desire alternative assets with which to grow their money.

Whether they are a tool for direct investment, a means of speculating, or as part of a hedge fund, there are a number of appealing alternative investment options that growing numbers of investors are choosing to investigate. Real estate investment trusts, gold, venture capital opportunities, and many other forms of investment have long flown under many investors’ radars but are worthy of consideration.

Gold Investing

Gold investing is the purchase and sale of gold bullion (physical gold). Unlike trading in the commodity markets, where one does not take physical possession of the substance in question, direct gold investment involves buying and selling actual gold: often in the form of coins, bars, or jewelry.

This makes it a more accessible form of investing for investors confused by the terminology or practices of commodity trading. It also acts as a hedge against the failure of various banking systems because the investor actually has the gold in his or her possession.

Gold investing has been around for centuries and has been wildly popular in recent years. Once the province of the wealthy alone, investors of all income levels now enjoy the benefits of gold investing. Given the relative popularity of gold as a precious metal, it remains one of the most widely used forms of nontraditional asset investment today, a fact easily recognized by the ubiquity of “cash for gold” storefronts in nearly every major city in the US.

Investing in gold bullion is surprisingly easy for the average consumer in the form of jewelry, coins, and even gold bars.  The physical possession of the gold can be a hedge against economic, political, social, or currency related risks.  The metal, however, is heavy and takes up space.

For those who wish to invest in gold without taking physical possession, Exchange Traded Funds (ETFs) replicate the movements in value of gold, or gold futures and options can be traded in the commodities market.  Trading in ETFs and commodities typically produces only an electronic record or a few sheets of paper.

Venture Capital

An exciting manner of corporate investment, venture capital allows businesses with limited operational histories to obtain the funding they need in order to get off the ground. Investors give their money to a company with high growth potential, and thus, high potential return on investment. Of course, these investments also carry significant risk of loss, as many fledgling businesses fail to achieve profitability. Yet, for the savvy investor with the means to sustain some losses in order to achieve potentially enormous gains, venture capitalism can be a very exciting and rewarding method of investment.

Venture capitalism involves giving financing to fledgling businesses. While acting as a venture capitalist can be a solo project, a number of firms specializing in venture capital investing do exist. Venture capital firms are usually partnerships, where the partners function as managers, chief investors, and financial advisers to other investors that use the firm’s services.

There are enormous potential profits. Returns on investment tend to be quite high, largely as a reflection of the relative risk involved and as a means of offsetting the inevitable losses investors experience on other, unsuccessful projects.

It is a very risky investment. Many companies will fail, and that could mean losing all or a part of one’s investment.

Real Estate Investment Trust (REIT)

Corporations that invest in real estate may organize as a Real Estate Investment Trust (REIT) in order to reduce or eliminate corporate income taxes. REITs trade on exchanges or through private placements, just like the stock of any corporation. Public stock exchanges list publicly held REITs, and these corporations must file reports with the Securities and Exchange Commission (SEC). This allows investors to research the key statistics of Net Asset Value (NAV), Adjusted Funds from Operations (AFFO), and Cash at Disposal (CAD).

Types of REITs

* REITs categorize primarily based on the types of real estate assets in which they invest.

* Equity REITs invest in and own properties. This makes them responsible for the equity (or value) of their properties. They derive most of their income from rents collected from tenants of the properties they own.

* Mortgage REITs earn money from transactions in mortgages. They either make loans to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Most of their income derives from interest on the mortgage loans.

* Hybrid REITs combine the investment strategies of both equity and mortgage REITs. They do this by investing in both properties and mortgages.

Real Estate Investment Trusts offer many advantages to people who do not have adequate funds to invest in real estate on their own, but still desire to own a piece of property. A REIT can pay regular dividends both when the trust uses the investor’s money to buy real estate and when the share price of the company appreciates.

A REIT must doll out 90% of its taxable profit as dividend to its shareholders each year, thus, they are usually labeled as high yield instruments similar to a small cap stock generating returns from dividends and share price appreciation.

Because of the way in which REITs trade, demand for other high-yield assets can negatively affect the share value of REITs. REITs also have additional tax considerations that other investment types do not. Specifically, REITs must pay property taxes, which can negatively affect investor payouts. Furthermore, high-yield REIT dividends have ordinary income tax consequences.

Private Equity

Akin to both traditional stock investing and venture capital, private equity investing deals with the equity securities of operating businesses that do not trade publicly on stock exchanges. Private equity investments in business ventures makes it easier for business organizations to focus on developing new products and services, often prior to taking a company public. Private equity also facilitates businesses exploring new business strategies. Private equity investments make it possible for companies to obtain needed funding even under unfavorable market conditions.

The most common form of private equity investment is direct lending of money by the investor to the interested company. Unfortunately, this often requires massive amounts of money on hand for the investor, as well as a long-term commitment to the company in question.

Fortunately, a number of investment firms focus exclusively on acquiring and managing private equity investments. These entities, known as “business development companies,” sell pieces of their private equity investments in the form of publicly traded stock in their firms. This gives average investors the opportunity to participate in private equity without having millions of dollars usually required to participate.

Successfully investing in private equity funds relies almost entirely on how well the business venture is functioning. As with any investment, big rewards usually are the result of big risks.

Options

Option trading involves understanding market conditions and using predictions to make investments. When an investor believes that an asset will appreciate in the future, the investor buys an asset at a premium value.

The instrument then gives the option holder the right to buy the underlying asset is known as a “call” option. While the investor has the right to buy, it is not an obligation. On the other hand, the seller of the option is obligated to sell when the option holder exercises the call.

A “put” option, on the other hand, gives the option holder the right to sell an asset before a predetermined date. The investor exercises this option if he or she believes that the price of the asset will fall before the expiration of the call options.

Options are quite flexible as an investing tool, so there are many variations available to investors. These might include short-term options of less than a year, long-term options that could last for several years, or “exotic” options that may actually be other types of investments with an option attached or with certain kinds of “optionality” built into them.

Options may also appeal to investors for the purposes of speculation and hedging. As a tool of speculation, option buyers make educated guesses (or “speculate”) on the extent of price movement in a financial instrument over a specific period. As a hedge fund, the investor uses the option to protect against (or “hedge”) against a possible downside in investments.

Options sometimes lack liquidity and they can be very complicated, especially for beginners.  Further, the lack of liquidity and complexity can bring higher commissions.

Futures

A form of derivative investment, investors buy and sell futures on exchange. Contracts to buy or sell a particular commodity at a specified price on a certain date in the future, futures are a means of speculating on commodities, energy, currencies, government bonds or other financial instruments. Futures differ from options in that the expiration date and amount to be paid are determined at the time of purchase rather than remaining open as in an option.

One of the main advantages of futures trading is that they are structured and traded on exchanges through clearing houses.  This can safeguard an investor from the counterparty not being able to live up to their end of the deal.

Forwards

Forwards are very similar to futures in that they are contracts to buy or sell an asset at a specified price, on a future date. Unlike standard futures contracts, however, a forward contract is between two parties and is a private agreement. This allows for a significant amount of customization to the type of commodity, the amount, and the delivery date.

Forward contracts do not trade in an exchange, making them over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk. As a result, forward contracts are not usually available to retail investors.