Understanding Alternative Investments

Alternative investments are those that fall outside the conventional investment types such as publicly traded stocks, bonds and cash. The terms “traditional” and “alternative” should not be taken to imply that alternative investments are uncommon or are relatively recent additions to the investments’ universe. Some actually date back further than other kinds. For example real estate and commodities, which are arguably two of the oldest investment classes fall under the umbrella of alternative investments. They also include non-traditional approaches to investing using special investment vehicles (SIVs) such as private equity funds, hedge funds and exchange traded funds (ETFs).

Compared to traditional investments, alternative ones are illiquid. In addition, the market performance of traditional investments and alternative investments is independent of each other. Therefore, inclusion of alternative investments in a portfolio can reduce its risk. Furthermore, alternative investments face fewer regulations and have less transparency than traditional ones. They also have limited data, which is not publicly available and also have unique legal and tax considerations.

The most pervasive alternative investments today are private equity and real estate. However, there are other, more specialized types, which also offer considerable returns. They include hedge funds, commodities and infrastructure.

Private Equity

Private equity generally involves buying shares in companies that are not listed on a public exchange or buying shares of public companies with the intent to make them private. Private equity can involve many strategies that may help provide money to companies at different stages of their development. The most widely used strategies are venture capital, buyouts and distressed investing. Venture capital is putting money into a small business or start up, which is felt to have great potential for growth in the long run. This investment strategy can occur at different stages of a business cycle. Angel investors finance a business in the early stages of operation while growth equity investors provide refinancing for established firms with proven business models that want to expand. Distressed investing involves funding companies in bad economic shape and finally, buyouts consist of financing established companies that require money to restructure and facilitate a change of ownership.

Private equity brings great potential for economic development especially through venture capital investments. It is a vast and unchartered land of opportunity. However, private equity investors still have to grapple with illiquidity and lack of access to information, which could hinder decision-making.

Real Estate

Real estate investments take different forms; both direct and indirect. For most people, it involves purchasing property. However, investors can also invest in public real estate equity for example REITs or public real estate debt for example, mortgage backed securities. The current market for property in Africa – whether it is residential, commercial or industrial –is being driven by rapid population growth and urbanization.

Some advantages of real estate investments include its ability to act as a hedge against inflation, its virtue of being visible and tangible and the high returns it offers. However, investing in real estate is capital intensive and causes the investor to be illiquid.

Other Alternative Investments

Investing in commodities could involve transacting on physical products such as grains, metals and crude oil, or through owning cash instruments, using derivative products, or investing in businesses engaged in the production of physical commodities. The main vehicles investors use to gain exposure to the commodities are commodity futures contracts and funds which are benchmarked to commodity indexes. Commodity indexes are typically based on various underlying commodities.

Hedge funds are private investment vehicles that manage portfolios of securities and derivative positions using a variety of strategies. They may use long or short positions, may be highly leveraged and aim to deliver investment performance that is independent of broad markelt performance.

Infrastructure assets are capital intensive, long-lived, real assets like roads, dams and schools, which are intended for public use and provide essential services. Infrastructure assets may be financed, owned, and operated by governments, although there is increasing participation by private players. Investors may gain access to these assets directly or indirectly.

Other alternative investments include tangible real assets such as fine wine, art, antique furniture and automobiles, stamps, coins, and other collectables. There also some intangible assets that individuals can invest in, such as patents.

Why invest in alternative investments?

For one, they can help to diversify your portfolio and reduce risk. Alternative investments have also historically outperformed traditional investments. On top of that, they provide social development to an economy. In real estate, they bring infrastructural development and uplift the image of the community while in private equity, they help create jobs and improve people’s standards of living.