Council Post: Understanding How Alternative Investments Fit In The Market

Investors should know and understand the categories of alternative investments and how they fit in a portfolio.

Council Post: Understanding How Alternative Investments Fit In The Market

Karl Rogers is Chief Investment Officer at

After a decade of financial markets rising, fueled by loose central bank monetary policies, 2022 was a harsh reality check. The central banks created a market environment of false hope. It created the most easy investment environment. You could buy any asset between 2010 and 2020, and it went up. This all changed in 2022, when both equity and bonds experienced difficult years. The former had its worst year ever. Diversification is crucial. A portfolio of bonds and equities has historically performed well in times of market stress. However, investors now need to diversify and seek out other investments to smooth out their returns. There are two types of alternative investments. This article will break down each category and discuss its role in an investor's portfolio. Alternative investments according to market definition is one category of alternative investments. This category can be described by first defining traditional markets and then understanding that there are alternative markets for any market that is not traditional. Traditional markets include equities as well as bonds. Equities refer to stocks/companies, while bonds refers to debt/loans to businesses and/or governments. Alternative investments can be any market that does not involve loans or stocks. This list does not include commodities, digital currency, FX, digital currencies, passion assets, art, cars, or watches. What is the primary function of these markets? Diversification from traditional markets.

A demand driver for sugar is less sugar consumption because of healthier eating habits. While the supply side has weather conditions that allow for the growth of the crops, it is the key. Diversification can be achieved if the fundamental drivers of these markets are different and continue to be so. These markets are easy to access as most of them can be accessed by retail investors via ETFs, UCIITS or ETCs. Alternative investments can also be called alternative investment structures. This subtle, but crucial nuance is important. Alternative investment structures include private equity, venture capital, hedge funds, private debt, and private equity. Venture capital, private equity, and private debt structures allow investors to access the equity and lending side of private companies. Investors don't receive the diversification benefits of alternative investments because all companies, public or private, are subjected to the same macroeconomic drivers. Why invest in these companies instead of traditional public structures? They can increase your return expectations.

The majority of value in a company's growth is achieved when they become public companies. Private companies are not subjected to the same central banks intervention as public markets. This means that private investments yield higher returns to investors. Return enhancing with diversification is the holy grail. Hedge funds may be the solution, but they are just a structure. Fund managers can use these structures to operate in traditional or alternative markets. A hedge fund equity short strategy, for example, is limited to traditional markets and does not provide the diversification investors desire. Hedge funds can be found in all markets, so there are many hedge funds available that provide diversification for investors looking for an alternative investment.

Alternative investment structures may not be as readily available as other investment markets. These investments are not liquid and only qualified investors have access to them. Based on the jurisdiction, the definition of qualified investors or an equivalent changes. These structures are available to Accredited Investors in the United States. An Accredited Investor can only be qualified if they have made more than $200,000 in three consecutive years or a married couple who have earned $300,000. These structures are available to MiFID Professional Investors in Europe. In Ireland, Qualifying Investors as well as MiFID Professional Investors may invest in them. Many in the industry are trying to make these structures more accessible to all. However, it is still a long way before this becomes a reality.

This information is not intended to be used as investment, tax, or financial advice. For advice specific to your situation, you should consult a licensed professional.

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