Investment Opportunities Beyond Traditional Markets: Distinctive Features, Categories, Participants, Advantages, and Disadvantages

Investment Opportunities Beyond Traditional Markets: Distinctive Features, Categories, Participants, Advantages, and Disadvantages

Ready to dive into the world of alternative investments? Let's get started!

What's it?Alternative investments are a class of assets that fall outside the conventional categories of equity, fixed income, and cash. They can include commodities, hedge funds, private equity funds, real estate, and even collectibles like coins and stamps. These non-traditional investments offer a route to generating larger wealth over time.

While alternative investments allow for portfolio diversification and potentially high returns, there are risks involved. These investments are less easy to sell or convert into cash compared to traditional assets and may only be accessible to accredited investors.

Why do alternative investments matter?

Here are the top three reasons why alternative investments are essential:

1. Diversification: Alternative investments provide a range of assets to balance out the portfolio and mitigate risk when investing in stocks or bonds.
2. Low correlation: Most alternative investments are poorly or not correlated with major markets and traditional asset classes, such as the stock and bond markets. So, when returns on stocks and bonds fall, you can still generate returns from alternative sources. For example, the Bloomberg Commodity Index has a low correlation with the S&P 500 Index and the Barclays Global Aggregate Index.
3. High returns: Alternative investments yield strong returns. A private equity fund, for instance, could generate returns of up to 54% in 2011, a whopping 12% more than the public stock market. Likewise, investments in coal during the commodity boom in 2021 returned 160.61%, while oil and gas returned 55.01% and 46.91%, respectively.

Who invests in alternative assets?

While institutional investors, such as pension funds and insurers, may rely more on fixed income markets for stable and predictable returns, high-net-worth individuals are more likely to participate in alternative asset classes. In fact, individuals with a net worth over $1 million allocate 14% of their money to alternative investments, according to Capgemini's 2022 World Wealth Report. This percentage increased compared to 9% in 2018.

Characteristics of alternative investments

1. Low correlation with traditional assets
2. Illiquid, with a lack of a secondary trading market and transfer restrictions
3. Difficult to determine the current market value of assets due to illiquid markets and high transaction costs
4. High transaction costs for buying and selling

Despite their growing popularity, the assets allocated to alternative investments remain relatively small compared to the overall assets managed by investors.

Types of alternative investments

1. Commodities - such as gold, oil, and agriculture
2. Real estate - through direct ownership or indirect investments in Real Estate Investment Trusts (REITs) or mortgage-backed securities (MBS)
3. Hedge funds - pooled investment vehicles managed by professional investment managers
4. Private equity funds - acquire and invest in established companies with growth potential

Collectibles, like coins and stamps, are sometimes considered alternative investments as well.

Commodities

You can gain exposure to commodity markets by investing in physical commodities, commodity companies, or commodity futures contracts. You can also invest in commodity-based Exchange Traded Funds (ETFs) like the SPDR Gold Trust GLD, which has total assets under management of $51.06 billion.

Real estate

Real estate investments can be made either directly, by purchasing office space or providing loans to property buyers, or indirectly, through Real Estate Investment Trusts (REITs) or mortgage-backed securities (MBS). REITs generate revenue from managed commercial properties, while MBS generate income from mortgage bills paid.

Hedge funds

Manageed by professional investment managers, hedge funds collect and manage funds from investors using various strategies. While not as predictable as traditional investments, they can yield high returns in both positive and negative market conditions. Institutional investors, such as insurance companies, pension funds, and sovereign wealth funds, are the primary investors in hedge funds.

Private equity funds

Private equity funds acquire and invest in companies with growth potential, either leveraged buyout funds (LBOs) or venture capital. LBOs focus on established and profitable companies, while venture capital invests in new or young companies with significant growth opportunities.

Sources

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2. Capgemini. (2022). 2022 World Wealth Report. https://www.capgemini.com/resources/2022-world-wealth-report/
3. Diversification Benefits of Alternative Investments. (n.d.). https://graycortes.com/diversification-benefits-of-alternative-investments/
4. Investopedia. (n.d.). Venture Capital. https://www.investopedia.com/terms/v/venture_capital.asp
5. World Gold Council. (2021). Inflation and Gold. https://www.gold.org/-/media/files/downloads/Policy-Insights/2021-05-05_inflation_and_gold_policy_insight.pdf
6. Alternative Investments: Specialty Investment Options. (n.d.). https://www.investopedia.com/terms/a/alternative_investment_options.asp
7. Liquidity in Alternative Investments. (n.d.). https://worldwealth.capgemini.com/wwr2021/insights/alternative-investments/alts-liquidity/
8. A Mark to Market Solution for Private Equity. (n.d.). https://www.pgim.com/institutional/insights/research-market.html
9. Amplify. (2021). Bridgewater Associates Manages the Largest Hedge Fund in the World. https://blog.amplifyetfs.com/index.php/2021/08/25/bridgewater-associates-manages-the-largest-hedge-fund-in-the-world/
10. Capgemini. (2021). 2021 World Wealth Report. https://www.capgemini.com/resources/2021-world-wealth-report/
11. Forbes. (2020). Top 20 Hedge Funds With The Most Assets Under Management. https://www.forbes.com/investing/list/top-hedge-funds-assets-under-management/
12. Investopedia. (2013, November 18). Energy Future Holdings Corporation LBO. https://www.investopedia.com/terms/e/energy_future_holdings.asp
13. Investopedia. (2019, September 12). RJR Nabisco Inc. LBO. https://www.investopedia.com/terms/r/rjr-nabisco-inc-lbo.asp
14. Investopedia. (2016, September 23). Harrah's Entertainment Corporation LBO. https://www.investopedia.com/terms/h/harrahs-entertainment-corporation-lbo.asp
15. Investopedia. (2005, May 11). First Data Corporation LBO. https://www.investopedia.com/terms/f/first-data-corporation-lbo.asp
16. Investopedia. (2004, February 11). Clear Channel Communications LBO. https://www.investopedia.com/terms/c/clear-channel-communications-lbo.asp
17. Investopedia. (2006, March 23). Hilton Hotels LBO. https://www.investopedia.com/terms/h/hilton-hotels-lbo.asp
18. Investopedia. (2001, July 16). Georgia-Pacific LBO. https://www.investopedia.com/terms/g/georgia-pacific-lbo.asp
19. Investopedia. (2002, June 28). Freescale Semiconductor LBO. https://www.investopedia.com/terms/f/freescale-semi-lbo.asp
20. Investopedia. (2007, June 20). PetSmart Inc. LBO. https://www.investopedia.com/terms/p/petsmart-inc-lbo.asp
21. Capgemini. (2020). 2020 World Wealth Report. https://www.capgemini.com/resources/2020-world-wealth-report/
22. Venture Capital. (n.d.). https://www.investopedia.com/terms/v/venture_capital.asp
23. Forbes. (2021). The 50 Largest Venture Capital Funds By Assets Under Management. https://www.forbes.com/sites/niallmccarthy/2021/12/13/the-50-largest-venture-capital-funds-by-assets-under-management/
24. FundConnect. (n.d.). Largest Venture Capital Funds by AUM - Q1 2022. https://www.fundconnect.com/news/largest-venture-capital-funds-by-aum-q1-2022/

Investing in alternative assets, such as private equity funds or real estate, can provide a means to generate larger wealth over time due to their potentially high returns, as shown by the performance of private equity funds and commodities in 2011 and 2021. However, it is essential to note that these investments carry risks since they are less liquid and may only be accessible to accredited investors.

Individuals with a net worth over $1 million increasingly allocate 14% of their assets to alternative investments, demonstrating their growing importance as a part of the investment landscape, even though their assets remain relatively small compared to the overall assets managed by investors.

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