Alternative Investments…Not Just Cryptocurrency
As your trusted advisor, the Aevitas Wealth team always acts in a fiduciary capacity. We are your partner and are constantly working to determine the best mix of investments for each client. Alternative investments, once limited to only high-net-worth and institutional investors, have recently become more available and mainstream. Many mutual fund companies now offer alternative strategy funds. As alternative investments become more accessible to different investors, we want to educate our clients about the risks and rewards.
What are alternative investments?
Alternative investments are those made outside of traditional asset allocation models of stocks, bonds, and cash. There are many types of alternative investments. The reasons for holding them across your portfolio differ based on the kind of investment and the investor's goals and risk profile. Perhaps the most well-known alternative asset is real estate, but many other niche asset types can play a role in your portfolio.
Each type of alternative investment has its own characteristics regarding how the asset's value performs relative to other economic and financial trends. Alternative investments are often used to refine portfolios, insulate wealth from broader economic issues, and negatively correlate with other asset classes.
Goals of alt investments
The current economic environment of historically low-interest rates, unprecedented monetary and fiscal policy, and a close correlation between asset classes has opened a greater discussion about the need for alternative investments. As always, the Aevitas Wealth team works with each of our clients to tailor custom-made goals and plans. As such, when adding alternative investments to a client's portfolio, we seek to:
Preserve wealth and grow assets
Provide greater diversification with low and negatively correlated investments
Reduce the impact of market volatility
Optimize tax strategies
What are the benefits and risks of alternative investments?
Alternative investments can be profitable and rewarding, but they're not appropriate for investors with alarmist tendencies. They're best suited for clients who understand and accept the advantages and risks of an investment in non-traditional asset types with long time horizons.
Benefits of alternative investments
Specific alternative assets have unique advantages. A common example is gold, which was historically used as a hedge against inflation. But some benefits apply to alternative investments as a whole.
Asset diversification: Alternative assets have a low, and sometimes even negative, correlation to the financial markets. Some alternatives will hold value or even increase during a bear market. Wealth invested in alternatives can be somewhat sheltered from negative macro trends.
Tax-efficiency: For tax purposes, most alternative investments are treated as pass-through entities. Important to note is that the Aevitas team does not advise allowing ‘the tax tail to wag the investment dog.’ In other words, it is not wise to buy or sell investments for tax reasons rather than the investment opportunity presented to you. However, alternative investments can provide compelling tax advantages that traditional investments do not.
Risks of alternative investments
There are risks that apply to both traditional asset classes and the category of alternatives.
Risk: Price fluctuations can be more unpredictable than traditional stocks and bonds.
Lack of pricing transparency: Many alternative investments are not exchange-traded, which means those assets are not continually repriced based on supply and demand. Therefore, there is typically less ongoing visibility into the asset's market value.
Less liquidity: Alternative assets are typically less liquid than stocks or bonds. Investors may also need to hold alternative assets for long periods before seeing any return or advantage.
Types of alternative investments
The category of alternative investments is constantly expanding, especially with the addition of cryptocurrencies. That being said, there are more typical 'mature' alternatives.
Real estate may be the most popular alternative investment, probably because it's widely accessible and less complex than other alternative asset classes. Real estate investors buy properties and generate gains through ongoing lease payments or by profiting on resale. Investors who prefer a hands-off approach can purchase shares of real estate funds and real estate investment trusts (REITs).
Commodities are raw materials and are primarily natural resources such as agricultural products, precious and industrial metals, oil, and natural gas. Because commodity prices rise when inflation is increasing, they are commonly used as a hedge against inflation. The value of commodities rises and falls with supply and demand. Investors can profit when greater demand levels result in higher prices. Commodity investing has been popular for many years, but modernization allows for the use of alternative strategies such as holding shares of an ETF that owns specific commodities or using a futures contract.
Private Equity and Venture Capital
A private equity investment provides capital for businesses that are not publicly traded. An investor could participate in private equity either directly or through a fund. Private equity funds are pooled investment vehicles managed by private equity firms. Investors can think of these investments as similar to a mutual fund. Still, it is essential to note that they are often not regulated in the same manner as traditional asset classes and are generally only available to accredited investors. Venture Capital is a subcategory of private equity that finances start-up companies with perceived high growth potential.
Hedge funds are actively managed pooled investment vehicles. Hedge fund trading strategies are typically very complex. Hedge funds typically use leveraged investments. A hedge fund's investments will vary but could utilize options or other derivatives, currency trading, short-selling, and purchasing distressed assets. Hedge funds are typically available only to accredited investors.
Private debt can be any loan made to a business or individual. An investor could loan money directly to a small business and take a security interest in the business as collateral. More commonly, accredited investors will buy into a private debt fund, which manages a portfolio of loans.
Structured products usually use equities, fixed income, and options trading. Examples of structured products include credit default swaps and collateralized debt obligations, such as mortgage-backed securities. Structured products are almost always highly complex investment products and are usually created by investment banks.
While newer in the headlines, cryptocurrency has been available for more than ten years, and it is anticipated that this will continue to evolve. Cryptocurrency is a disruptive digital technology, or virtual currency, secured and exchanged via blockchain technology. Payments and other digital transfers can currently occur without a bank or government mediator. Cryptocurrency is still considered a speculative alternative investment, primarily due to concerns about volatility, valuation, and application.
How do I add alternative investments to my portfolio?
Technology is revolutionizing access to alternatives. Newer product offerings that were previously only available to ultra-high net worth and institutional investors are more open to a broader range of investors. By incorporating alternative investments into your portfolio, additional long-term wealth can be created and preserved by further driving diversification and using tax-advantaged strategies.
This is meant to be a simple review of a highly complex subject. Contact the Aevitas Wealth team to discuss alternative investments and the best strategies for you and your portfolio.