Have you ever wondered where you could invest money other than in stocks? What are alternative investments and how do you invest in such assets?
To give you a comprehensive view, we have listed the different types of alternative investments.
An alternative investment is an asset that does not fall into one of the traditional equity (publicly traded), fixed-income securities, and cash categories.
Real or tangible assets (such as natural resources, commodities, real estate, intellectual properties and collectibles), hedge funds, private equity and structured financial products are all examples of alternative investments. Most alternative investments are unregulated by a financial authority.
The term investment covers a very broad spectrum: A good definition of an investment is that it is deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment.
For the purpose of this article, we classify five types of alternative investments (1) Real or tangible assets, (2) Hedge funds, (3) private equity, (4) structured financial products and (5) Digital Assets.
|REAL ASSETS||Natural Resources|
|HEDGE FUNDS||Macro and Managed Futures Funds|
|Event-driven Hedge Funds|
|Relative Value Hedge Funds|
|Equity Hedge Funds|
|Funds of Hedge Funds|
|PRIVATE EQUITY||Venture Capital|
|STRUCTURED PRODUCTS||Securitisation Products|
|Securities linked to financial instruments|
|DIGITAL ASSETS||Security Tokens|
1) Real or Tangible Assets
Definition : Real or Tangible assets are economic resources that create or add to the consumption opportunities available to people. All consumption ultimately originates from real assets. Financial assets serve as conduits of value rather than as direct creators of consumption opportunities.
Within the clqss of real or tangible assets, five types can be identified: (1) Natural resources, (2) Commodities, (3) Real Estate, (4) Intellectual properties and (5) Collectibles.
1.1 - Natural resources
Definition: Natural resources are real assets that have received no or almost no human alteration.
Examples of natural resources include oil, natural gas, coal, ore, land, water, wind and other inputs to production that largely remain in a natural state and location. Most natural resources are related to facilitating energy consumption because energy is such a major input to the world economy.
A large portion of natural resources is under the earth’s surface. In most jurisdictions, private land ownership is limited to surface rights, with the ownership of underground mineral and energy rights retained by governments.
Public or private owners of natural resources often lease their natural resource rights to developers for eventual extraction. Thus, effective economic ownership of natural resource is often accomplished through the purchase or leasing of rights rather than through transfer of recorded property ownership.
In other words, ownership of natural resources can be achieved through land ownership that includes underground rights, ownership of mineral rights, or leasing of mineral rights.
1.2 - Commodities
Definition: Commodities are tangible goods (i.e. raw material or primary agricultural products) that can be traded for other tangible goods or cash.
Within the commodities asset class, three types can be identified: (1) Agricultural products, (2) Energy related resources, and (3) Raw materials.
1.3 - Real Estate
Definition: Real estate has been a large and important portion of wealth for thousands of years. Even as recently as a century ago, real estate dominated institutional portfolios and was referred to as property. Private real estate has transitioned from dominating traditional institutional investment to being considered by many as alternative investment.
Real estate is a highly heterogeneous asset but height types can be identified: (1) Offices, (2) Retail / Commercial real estate, (3) Multi-family / Residential real estate, (4) Resorts / Hotels, (5) Healthcare real estate, (6) Industrial real estate, (7) Infrastructure real estate, (8) Other real estate.
1.4 - Intellectual properties
Definition: Intellectual properties (IPs) are intangible assets that can be owned, such as copyrighted artwork.
IPs may be acquired and financed at various stages in their development and exploitation. Initially, newly created IP may have widely varying value and use.
Early-stage types of such as exploratory research, new film production or implementation are like call options with most instances failing to recapture initial costs. In contrast, mature Ips typically have more certain value and more certain ability to generate licencing, royalties, or other income than do early-stage projects.
Patents: Any innovative idea relating to a product, a method of manufacture, or an application of a known method of manufacture leading to a practical solution to a technical problem.
Copyrights: Any innovated work, in literature, artistic (example with Anote Music) or scientific domain, whatever the type, manner of expression, significance or purpose of classification thereof.
Trademark: Anything which takes a distinctive form, used or intended to be used, either in distinguishing goods, products or services whatever their origin is.
Franchises: Franchising is an arrangement in which the franchisor gives the franchisee the right to distribute and sell the franchisor’s goods or services and use its business name and business model for a specified period, and possibly covering a geographical area.
1.5 - Collectibles
Definition: Collectibles are objects collected either for their investment value or because the collector has a personal interest in the objects. They are assets of limited quantity and the perception of high value.
Any object can become a collectible, but typically the most popular collectibles are Classic Cars (examples), Thoroughbred Horses, Stamps, Precious metals (examples), Jewelry and Gems, Fine Art (examples), Rare coins, Fine Wines and other rare beverages (examples) and Timepieces.
2) Hedge Funds
2.1 - Macro and Managed Futures Funds
Definition: Macro and managed futures funds share many common features. As their name implies, global macro hedge funds take a macroeconomic approach on a global basis in their investment strategy.
These are top-down managers which invest opportunistically across national borders, financial markets, currencies, and commodities. They take large positions that are either long or short, depending on the hedge fund manager’s forecast of changes in equity prices, interest rates, currencies, monetary policies, and macroeconomic variables such as inflation, unemployment, and trade balances. Global macro funds have the broadest investment universe: They are not limited by market segment, industry sector, geographic region, financial market, or currency and therefore tent to offer high diversification.
The term managed futures refers to the active trading of futures and forward contracts on physical commodities, financial assets, and exchange rates. Managed futures strategies tend to be based on systematic trading more than discretionary trading.
2.2 - Event-driven Hedge Funds
Definition: The event-driven category of hedge-funds include activist hedge funds, merger arbitrage funds, and distressed securities funds, as a well as special situation funds and multi-strategy funds that combine a variety of event-driven strategies. Event-driven hedge funds speculate on security price movements during both anticipation of and realisation of events. Event include, mergers and acquisitions, spin-offs, tracking stocks, accounting write-offs, reoganisations, bankruptcies, share buybacks, special dividends, and any other corporate events that are generally associated with substantial market price reactions in the securities related to the transactions.
Within the event-driven class of hedge funds, four styles can be identified: (1) activist funds, (2) merger arbitrage funds, (3) distressed securities funds, and (4) multi-strategy event-driven funds.
2.3 - Relative Value Hedge Funds
Definition: Relative value strategies attempt to capture alpha through predicting changes in relationships between prices or between rates. For example, rather than trying to predict the price of oil, a relative value strategy might predict that there will be a narrowing of the margin between the price of oil and the price of gasoline. Relative value fund managers take long and short positions that are relatively equal in size, volatility, and other exposures.
Within the relative value class of hedge funds, four styles can be identified: (1) convertible bond arbitrage, (2) volatility arbitrage, (3) fixed-income arbitrage, and (4) relative value multi-strategy funds.
2.4 - Equity Hedge Funds
Definition: Equity hedge funds of all styles share a common strategy focused on taking long positions in undervalued stocks and short positions in overvalued stocks. The success of funds within each of these strategies is primarily related to the extent to which a manager is successful in establishing long positions in stocks that outperform the market and short positions in stocks that underperform the market. It is not necessary for the long positions to increase in value and the short sales to decline in price for the equity manager to profit.
2.5 - Funds of Hedge Funds
Definition: The fund of hedge funds is a diversified fund run by a single hedge fund manager, in which assets are allocated among other hedge funds. A key goal of investing in a fund of funds is to improve portfolio diversification, as a fund of funds quickly diversifies bot the risks of concentrated hedge fund styles and the risks of investing with single hedge fund managers.
3) Private Equity
Definition: Private equity is as old as commerce itself. Virtually every major enterprise began small, unlisted firm. Private equity is a long-term investment process that requires patience, due diligence, and hands-on monitoring.
From a more general perspective private equity provides the long-term equity base for a company that is not listed on any exchange and cannot raise capital via the public equity market. Private equity provides the capital investment and working capital that are used to help private companies to grow and succeed.
3.1 - Buyouts
Definition: Buyouts, in the context of private equity, are the purchase of a public company by an entity that has a private ownership structure. Buyouts are distinguished from mergers by the extent to which the firm that is bough is intended to function as a stand-alone business rather than to be folded into the organisation of the purchaser.
Distinctions between buyouts tend to focus on 1) the purpose of the buyout and 2) the management team that will operate the target firm. The largest type of buyout is a leveraged buyout.
3.2 - Venture Capital
Definition: Venture Capital (VC), the best known of the private equity categories, is an early-stage financing for young firms with high potential of growth that do not have a sufficient track record to attract investment capital from traditional sources, like public makers or lending institutions.
Banks, other lending institutions, and the public stock market are generally unwilling to provide capital to support business plans without collateral or without reasonably high probabilities of positive cash flows in the short run. As the source of equity financing to start-up companies, VC is risky, illiquid, and backed by unproven ideas. The strategy is to strive for a very high rates of return to compensate for the considerable risks.
3.3 - Mezzanine debt
Definition: Mezzanine financing is generally not used to provide cash for the day-to-day operations of a company. Instead, it is used during transitional periods in a company’s life. Frequently, a company in a situation in which its senior creditors are unwilling to provide any additional capital, and the company does not whish to issue additional stock. Mezzanine can fill this void. Additionally, mezzanine debt is closely linked to the buyout market, since it is often used to finance buyouts.
3.4 - Distressed debt
Definition: Distressed debt investing is the practice of purchasing the debt of troubled companies, requiring special expertise and subjecting the investor to substantial risk. These troubled companies may have already defaulted on their debt, may be on the brink of default, or may be seeking bankruptcy protection. Like the other forms of private equity, this form of investing requires long-term horizon and the ability to accept the lack of liquidity for a security for which often no trading market exists.
3.5 - Leveraged Loans
Definition: Leveraged loans is another asset class of fixed-income securities that private equity firms have moved into. Leveraged loans are syndicated bank loans to non-investment-grade borrowers. The term syndicated refers to the use of a group of entities, often investment banks, underwriting a security offering or, more generally, jointly engaging in other financial activities. Loans made by banks to corporations can be divided into two general classes: (1) those made to companies with investment-grade credit ratings (BBB or Baa and above), and (2) those made to companies with non-investment-grade credit ratings (BB or Ba and lower). This second class of loans refers to leveraged loans.
In many respects, leveraged loans are similar to high-yield debt or junk bonds in terms of credit rating and corporate profile.
4) Structured Products
4.1 - Securitisation products
Definition: Structuring, in the context of alternative investments, is the process of engineering unique financial opportunities from existing asset exposure. An example of a structured product is an investment specially designed to provide downside protection against losses while offering potential profits through exposure to increases in the value of an index or an underlying.
4.2 - Credit derivatives
Definition: Derivatives are cost-effective vehicles for the transfer of risk, with value driven by an underlying asset. Credit derivative transfer credit risk from one party to another such that bot parties view themselves as having an improved position as a result of the derivative. Roughly, most credit derivative transactions transfer the risk of default from a buyer of credit protection to a seller of credit protection.
4.3 - Securities linked to financial instruments
4.4 - Hybrid products
Definition: Hybrid Instruments are a broad group of securities that combine the elements of the two broader groups of securities, debt and equity.
Hybrid securities pay a predictable (fixed or floating) rate of return or dividend until a certain date, at which point the holder has a number of options including converting the securities into the underlying share.
Therefore, unlike a share of stock (equity) the holder has a ‘known’ cash flow, and, unlike a fixed interest security (debt) there is an option to convert to the underlying equity. More common examples include convertible and converting preference shares.
A hybrid security is structured differently and while the price of some securities behave more like fixed interest securities, others behave more like the underlying shares into which they convert.
5) Digital Assets
5.1 - Security tokens
Definition: These are tokens of special characteristics that are similar to traditional instruments like shares, debentures or units in a collective investment scheme.
Example: Science Blockchain token
5.2 - Cryptocurrencies (or exchange tokens)
Definition: Cryptocurrencies are the most common type of digital asset, and they use cryptography for security, designed to work as a medium of exchange.
5.3 - Stablecoins
Definition: Stablecoins are digital assets that attempt to stabilize its volatility by typically pegging themselves to a stable asset such as the US Dollar or gold. They are gaining traction with investors who favour security over high returns.
Example: Gemini dollar
5.4 - Utility tokens
Definition: Digital tokens seek to provide value to investors by giving them access to a future product or service. For example, a startup may develop a digital product/ service and issue utility tokens to investors. Investors may then use those tokens at some future time, to obtain access to the issuers products/service.
5.5 - E-Money tokens
Definition: These are tokens that are designed to function as a form of electronic money that represent a claim on the issuer, are issued on receipt of funds for the purpose of making payment transactions, and are accepted by a person other than the issuer.
Example: Diem (formely know as Libra)
Mat is the founder of cashtipsandtricks and has been working in the financial sector in Luxembourg for the past 10 years and brings his insights as an investor and entrepreneur.