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An alternative investment is an investment in asset classes other than stocks, bonds, and cash. The term is a relatively loose one and includes tangible assets such as precious metals, art, wine, antiques, coins, or stamps and some financial assets such as real estate, commodities, private equity, distressed securities, hedge funds, carbon credits, venture capital, film production, financial derivatives, and cryptocurrencies. Investments in real estate and forestry are also often termed alternative despite the ancient use of such real assets to enhance and preserve wealth. In the last century, fancy color diamonds have emerged as an alternative investment class as well. Alternative investments are to be contrasted with traditional investments.
There is a wide variety of literature on alternative investments; however, this term has been used broadly and can also refer to financial alternatives such as derivatives or other alternatives such as energy. It is difficult to find research on the investment characteristics of tangible alternatives such as art or wine due primarily to a lack of good quality data. The Goizueta Business School at Emory University has established the Emory Center for Alternative Investments to provide research and a forum for discussion regarding private equity, hedge fund, and venture capital investments. William Baumol used the repeat sale method in a 1986 paper in The American Economic Review, comparing the prices of 500 paintings sold over 410 years, concluding that the average annual return on art was 0.55% (after taking inflation into account). A master's thesis by Dennis Kundu and Alexander Raza studied the return on investment on high-quality oil paintings sold in Sweden between 1985 and 2016, and found the average return to be merely 0.6% annually.
As with any investment, it’s important to do your homework, but in the case of many alternative investments, some specialist knowledge on the specific asset is often needed. Therefore, it’s important that would-be investors have a reputable broker or investment company on their side with demonstrable success in their asset class arena, which are happy to work with you to identify your ideal investment solutions.
Access to alternative investments
In recent years, the growth of alternative finance has opened up new avenues to investing in alternatives. These include the following:
Equity crowdfunding platforms allow "the crowd" to review early-stage investment opportunities presented by entrepreneurs and take an equity stake in the business. Typically an online platform acts as a broker between investors and founders. These platforms differ greatly in the types of opportunities they will offer up to investors, how much due diligence is performed, degree of investor protections available, minimum investment size and so on. Equity crowdfunding platforms have seen a significant amount of success in the UK and, with the passing of JOBS Act Title III in early 2016, are now picking up steam in the US.
The investor-led model was introduced by UK-based crowdfunding platform SyndicateRoom and makes it necessary for any startup seeking funding to first be vetted by an experienced investor that is also investing a significant amount (25% or more) of the target round.
SEIS and EIS funds
Only available in the UK, SEIS funds and EIS funds present a tax-efficient way of investing in early-stage ventures. These work much like venture capital funds, with the added bonus of receiving government tax incentives for investing and loss relief protection should the companies invested in fail. Such funds help to diversify investor exposure by investing into multiple early ventures. Fees are normally charged by the management team for participating in the fund, and these can end up totalling anywhere between 15% and 40% of the fund value over the course of its life.
Private equity consists of large-scale private investments into unlisted companies in return for equity. Private funds are typically formed by combining funds from institutional investors such as high-net-worth individuals, insurance companies, pension funds etc. Funds are used alongside borrowed money and the money of the private equity firm itself to invest in businesses they believe to have high growth potential. In Europe, venture capital, buy-ins and buy-outs are considered private equity.
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The Merrill Lynch/Cap Gemini Ernst & Young World Wealth Report 2003, based on 2002 data, showed high-net-worth individuals, as defined in the report, to have 10% of their financial assets in alternative investments. For the purposes of the report, alternative investments included "structured products, luxury valuables and collectibles, hedge funds, managed futures, and precious metals". By 2007, this had reduced to 9%. No recommendations were made in either report about the amount of money investors should place in alternative investments.
Alternative investments are sometimes used as a way of reducing overall investment risk through diversification.
Some of the characteristics of alternative investments may include:
- Low correlation with traditional financial investments such as stocks and bonds
- It may be difficult to determine the current market value of the asset
- Alternative investments may be relatively illiquid (see "Liquid alts")
- Costs of purchase and sale may be relatively high
- There may be limited historical risk and return data
- A high degree of investment analysis may be required before buying
Liquid alternatives ("alts") are alternative investments that provide daily liquidity. Liquid alternative investments should produce returns uncorrelated to GDP growth, must have protection against systemic market risk and should be too small to create new systemic risks for the market. Hedge funds may be included in this category; however, traditional hedge funds may have liquidity limitations, and the term is usually used for registered mutual funds which use hedge fund strategies such as long-short equity investments.
Liquid alternatives became popular in the late 2000s, growing from $124 billion in assets under management 2010 to $310 billion in 2014. However, in 2015 only $85 million was added, with 31 closed funds and a high-profile underperformance by the largest long-short equity fund at the time, Marketfield Fund.
In 2014 there were an estimated 298 liquid alternative funds with strategies such as long-short equity funds; event driven, relative value, tactical trading (including managed futures), and multi-strategy. This number does not include option income funds, tactical shorting and leveraged indexed funds.
There has been expressed skepticism over the complexity of liquid alts and the lack of able portfolio managers.
- Liquid Alternative Investment
- Chartered Alternative Investment Analyst
- Philatelic investment
- Traditional investments
- Platinum as an investment
- Gold as an investment
- Palladium as an investment
- Silver as an investment
- Lithium as an investment
- Investment wine
- Diamonds as an investment
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- H. Kent Baker and Greg Filbeck (2013). Alternative Investments: Instruments, Performance, Benchmarks and Strategies. John Wiley & Sons. ISBN 978-1-118-24112-7.
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