What Are Alternative Investment Funds? Different Types, Benefits

Alternative investments (such as a mutual fund or rare collectibles) is an asset class that helps investors to diversify their portfolios. 

Unlike fixed income and traditional investments (like bonds and stocks), alt investments aren’t greatly affected by the stock market. So if the market goes down, alternatives can serve as great volatility absorbers.

Alternative assets are also known for their high returns on investment. 

Let’s explore one of the most common alternatives - alt funds, including how they work, the main alternative fund types, why you should invest in them, and what factors to consider before investing. Additionally, we will cover how you can invest in wine (one of the best alternatives) through Vinovest.

Alternative Investment Fund Investment Strategies

Alternative funds are mutual funds, exchange-traded funds (ETFs), or hedge funds that invest in non-traditional assets such as real estate, alcohol, and commodities. 

Before you invest in alternative funds, it’s important to understand their investment objectives and strategies.

• Investment objective: Depending on the asset manager, some alternative funds might only specialize in one asset type. Others might have an investment objective to reduce risk by investing in various alternative asset classes. You can choose the alternative fund that best suits your needs and match it to your personal investment objectives.

• Investment strategy: Alt funds often have higher expenses and risks because they require active management. That’s because the alternative fund manager usually adopts more complex trading and investment strategies. These include “market neutral,” “absolute return,” and leverage strategies or implementing things like derivatives and selling stocks short. 

Now, let’s explore the main alt funds you can invest in.

Types of Alternative Investment Funds

Before choosing the alternative investment type you want to invest in, keep in mind that you need to be an accredited investor to access most of them (non-professional and retail investors might need to fulfill additional requirements to qualify.) 

Here are the five main alternative investment fund types:

1. Private Equity Funds
2. Hedge Funds
3. Venture Capital Funds
4. Real Estate Funds
5. Fund of Funds

1. Private Equity Funds

A private equity fund is an investment vehicle that pools capital from professional investors and uses it to buy stakes in public and private markets and companies (unlike private credit, where the investor lends money to the company instead of owning part of it.) Then the fund takes on an active role in these companies and provides them with guidance and capital. 

The aim is to accelerate the company’s growth and increase its profits. The private equity fund exits once it takes the company to an initial public offering (IPO) or sells its stake to another company. 

2. Hedge Funds

A hedge fund usually caters to only accredited and institutional investors. 

Hedge funds are actively managed by experienced investors who aim to achieve the highest possible return (usually higher than the markets.) The hedge fund strategy is more complex, and the investment manager might invest in various assets like real estate, fine wine, art, and derivatives. Often they use leverage (borrowing money), which makes this a high-risk investment. 

3. Venture Capital Funds

A venture capital fund provides funding for startups in exchange for a stake in the company. While these funds are considered very risky, they also offer high return opportunities. However, they’re usually accessible only to accredited investors.

A venture capital investor is usually committed to developing the startup company. Individual investors are involved in meeting the company’s goals, monitoring progress, and providing guidance. They are often part of the board of directors and exit the company once they close an acquisition, merger, or IPO.

4. Real Estate Funds

This alternative fund invests in securities offered by public real estate companies or REITs (real estate investment trusts.) They provide value through the appreciation of the tangible assets and can be either passively or actively managed. Real estate fund assets can be bought directly from the company that created the fund or from an online brokerage. 

Such funds are not suitable for investors looking for short-term capital gains since they require a long-term commitment.

There are three main types of real estate funds: 

• Real estate mutual funds: These usually require a high initial investment and can be close- or open-ended.
• Real estate exchange traded funds: These funds own real estate investment trusts and real asset shares.
• Private real estate investment funds: Alternative investment managers of such funds invest directly in real estate properties.

5. Fund of Funds

A fund of funds (FOF) is usually structured as a traditional mutual fund, hedge fund, or private equity fund. 

FOFs usually invest in other alternative mutual funds or hedge funds. Thus their portfolios consist of other funds’ portfolios rather than investment product assets (traditional investments) such as stocks and bonds. 

Their strategy involves maximizing portfolio diversification, minimizing risk, and balancing asset allocation. However, investing in this type of alternative mutual fund usually comes with higher expense ratios. 

Why Invest in Alternative Investment Funds?

Investing in alternative investment funds has a few advantages:

• Higher returns: While alt funds have a higher risk, they also entail the potential for higher returns on investment.

• Low stock market correlation: One of the best things about alternative funds is that they preserve (or sometimes even increase) their value when the stock market is down.

• Lower volatility: The exposure of alternative funds to the broad investment market is limited, thus, they have lower volatility.

• Portfolio diversification: Due to the low stock market correlation, alternative investments are a great way to diversify your portfolio.

• Hedge against inflation: Funds that invest in tangible assets such as gold, wine, real estate, and oil are a great way to hedge against inflation and high price fluctuations.

Factors to Consider Before Investing in Alternative Funds

While the alternative investment funds offer some great benefits, you should also be aware of the following factors that impact their performance:

• Higher risk: Alternative funds are usually high-risk investments, which is why they’re usually accessible to accredited investors and retail investors that pass certain requirements. 

• Higher initial investment: Alternative investments are mainly restricted to accredited investors also because they require a high initial investment. For example, investors might need to abide by certain financial condition requirements, such as having a net worth of $1 million or an annual income of $200,000.

• Higher expenses: Due to the more complex structure and active investment manager involvement, alternative investment funds usually come at a higher cost (expense ratio can easily be above 1.5%.) 

• Vague structure: Alternative funds do not usually have a clear legal structure, and often their contents are not very clear.

• Difficult valuation: Alternative investment assets are generally hard to value. That’s because they don’t have an official market price (like traditional stocks), and the appraiser’s subjectivity influences their value.

• Low liquidity: Since many alternatives are not traded publicly, they’re also less liquid than traditional investment assets. Some hedge funds and private equities also require the investor to commit for a certain amount of time before selling their assets.

• Alternative fund managers’ experience: The alternative fund performance heavily depends on the fund manager and their competence. So, before you choose an alt fund, do background research on its asset managers and their experience to ensure you get accurate investment advice. 

• Performance history: Avoid funds with short performance histories. When choosing a fund, try to find data for the past five years. While this is no guarantee for future success, it will give you a good idea of what to expect from the fund. 

Wine as Alternative Investment & How To Invest In It

Wine is one of the best alternative investments that’s quickly gaining popularity. The Liv-ex 1000 (tracking the mid-price of 1000 wines from across the world) has increased by 7.25% in the first quarter of 2022, and we predict it will keep growing steadily.

Fine wine is also a great alternative asset class with stellar returns on investment and low volatility, especially during unstable economic conditions. It’s one of the safer long-term investments you can add to your portfolio if you don’t want to take on the higher risk of investing in alternative funds.

If you want to start your journey in the fine wine investment world, check out Vinovest. The advanced AI-based platform helps you buy, store, and sell fine wines from around the world. 

Additionally, Vinovest is not limited to only institutional investors. Individual investors can also sign up on the platform and get professional investment advice and assistance every step of the way. Vinovest’s Master Sommeliers and data analysts will curate a winning wine portfolio tailored to your needs and risk tolerance.

Are you ready to get started?

Diversify Your Portfolio Today!

Alternative investment funds present an amazing opportunity to diversify your portfolio. However, their complex nature makes them also a more risky and expensive investment. 

If you’d like to start investing in alternatives but still be on the safer side, you can try investing in collectibles like fine wine.

Sign up on Vinovest to start your fine wine investment portfolio today.