What Are Alternative Investments? (Pros & Cons, Different Types)

by Hunter Robillard

What are alternative investments, and how do they work?

Quite simply, an alternative investment refers to any financial asset that doesn’t fall into the category of stocks, bonds, or cash.

You’ll find a wide variety of alternative investments to choose from, including collectibles like wine, private equity, hedge funds, commodities, derivatives, real estate, and more.

They offer exciting opportunities for diversifying your investment portfolio, shielding you from market volatility.

In this article, we’ll answer those questions, look at what are alternative investments, why you should add them to your portfolio, six types of alternatives (including wine), and how Vinovest can help you invest in wine.

How Alternative Investments Work: What Are Their Characteristics?

An alternative investment is generally perceived as more complex than most traditional investment strategies. As a result, it was believed that many of these asset types are only available to institutional and accredited investors.

This is partly because many of these have high investment minimums and fees, especially compared to traditional asset classes like an income fund, such as a mutual fund or exchange-traded fund (ETF).

But, there are exceptions - like fine wine! (We’ll tell you more in a bit).

Before that, a deeper dive into the pros and cons of this unique investment avenue will help you better understand its characteristics.

Pros and Cons of Alternative Investments

Investing in alternative assets comes with some unique pros and cons.

Pros: Why Invest in Alternative Assets

Almost every financial advisor will give you the same investment advice: investing in alternative assets is generally a sound investment decision.

There are several major reasons for this.

1. Low correlation: Correlation refers to the relationship between two assets. Alternatives tend to have a low correlation with the standard asset class. So, alternative asset prices are more likely to move inversely to those trading on the public market.

This makes them useful for diversification and achieving your investment objectives. Investing in hard assets like real estate and commodities can provide the added benefit of acting as a hedge against inflation.

For this reason, many large institutional funds, such as pension funds, often allocate a small portion of their portfolios to alternative investments like hedge funds.

2. Improved risk-return profile: Alternative assets can improve the risk-return profile of an investment portfolio and increase total returns through access to a broader range of investments and strategies.

3. Greater accessibility: Alternative investments have historically been geared towards sophisticated investors. However, it’s becoming easier for everyday retail investors to take advantage. Retail investors also have access to alternative investments like an alternative mutual fund and exchange-traded fund. These alt funds are publicly offered and SEC-registered but may hold non-traditional investments or employ complex investment strategies.

For example, wine investing platforms like Vinovest have made wine investing much more convenient, while others like Masterworks have opened art investments to the general public.

Cons of Alternative Investments

While there are a host of attractive benefits, it’s essential to understand the negatives as well.

1. Tough to value: Some alternative tangible assets can also be challenging to value, depending on their scarcity. The more scarce it is, the tougher it would be to compare historic prices. More so, since companies don’t have to disclose the same financial information, the underlying assets of the alternative investments can be difficult to value.

2. Illiquidity: Alternative investments are often more illiquid and require longer investment timelines than the more traditional options.

After investing, there’s a chance the funds are locked until the investment reaches maturity.

Further, the investment may only mature after five or ten years. And, not every alternative investment will provide returns during this time - some may only payout at the maturity date. This means you need to be acutely aware of any near-term financial needs and investment objectives.

3. Lack of transparency in regulations: Alternative investments aren’t subject to the same regulation as most traditional assets. This lack of regulation in the private market is a risk. It makes alternative assets more opaque than the public market.

For example, let’s look at how the US Securities and Exchange Commission (SEC) views these assets.

Publicly traded investments are subject to the 1940 Investment Act, which regulates investment funds. An exemption in this Act means many alternative investments aren't subject to the same legal structure as traditional asset classes. Also, some of these platforms don't have to register with the SEC, and they’re not overseen or regulated by the agency in the same way as traditional assets are.

4. Accessibility: Some alternative investments are only available to institutional or accredited investors.

(An institutional investor refers to any company or organization that invests on behalf of its clients.

An accredited investor is someone with an income exceeding $200,000 in the previous two years or a joint income of more than $300,000. An accredited investor may also have a net worth exceeding $1 million, excluding the value of the primary residence.)

In any case, the pros outweigh the cons.

It pays to look beyond traditional investment avenues like stocks, bonds, and cash. Alternative investments should form an important part of any investment strategy.

Next, let’s take a look at some alternative assets worth investing in.

6 Types Of Alternative Assets You Should Explore

There are various types of alternative assets, including:

1. Collectibles Like Fine Wine

Of course, some investors prefer to invest in a few tangible assets. Collectibles refer to a real asset that can be sold for more than its original price.

It could be sports memorabilia, coins, stamps, comic books, action figures, art, antique cars, and much more.

Of these, wineremains one of the most robust long-term investments. Historically, wine investments are low risk, offering stable returns year after year.

In fact, wine has outperformed the Global Equity Index by 1.88% annually for the last 15 years and has remained stable in the previous five decades, regardless of global economic conditions. Wine also has little correlation with stock market returns, making it effective for diversification.

Moreover, wine is considered a wasting asset in countries like Austria, Germany, France, the UK, and Hong Kong. Wine investments made in these countries are tax-free. Countries like Bermuda and Panama also allow tax-free wine investing.

It’s no wonder that wine has outperformed stocks, precious metals, and art for over 100 years. If you had invested $200 in the wine market in 1960, you’d have over $480,000 now.

There are several reasons why wine is a valuable investment product:

Scarcity: The world’s best wineries produce limited quantity vintages, often making even fewer investment-grade bottles, no more than several hundred sometimes. Investment wines make up less than 0.1% of the world’s total wine production. These bottles become harder to find with time and, therefore, more valuable.

Maturity: Unlike many other tangible investments, wine improves with age. This process can take decades as the wine’s value increases closer to maturing.

Brand equity: Some of the best wine brands in the world, like Louis Roederer, Moët & Chandon, Screaming Eagle, and Domaine De La Romanée-Conti, command high prices purely because of their longstanding reputation for producing some of the world’s best wines.

Now:

What Is The Smartest Way To Invest In Wine?

Vinovestoffers a super-easy way to curate a portfolio of investment-grade wines. It is a leading wine investment platform that offers the easiest way to source, manage, and grow a portfolio of investment-grade wines.

Vinovest takes care of authenticating, insuring, and storing your wines - all of which are time-intensive and costly to do on your own.

2. Private equity

Private equity is an alternative asset class referring to a broad range of investments made into a private company, or companies only available in the private market. When investing in a private equity fund, investor money can be locked up for 10 years before the private equity fund sells its holdings.

Transparency is often an issue with private equity, as backers invest in a blind pool and won’t know what the private company is until after the manager has funded the investment.

Venture capital is a subset of private equity. It involves investing in early-stage companies in exchange for a stake in the business. Venture capital is a particularly risky investment since many of these businesses are still in the infancy stage and may not have stable revenues. However, it can be one of the most lucrative investment opportunities.

3. Private debt

Private debt, also called private credit, refers to investments that aren’t financed by a bank (i.e., through a loan) or traded on an open market. Typically, companies leverage private debt when they need capital to grow their business. The companies that provide the loan are called private debt funds.

There are several different types of private credit, including corporate, real estate, and infrastructure debt. There’s also distressed credit, but this is much riskier as it invests in companies in financial trouble.

4. Hedge Funds

A hedge fund is an investment trading relatively liquid assets using various investing strategies to provide returns regardless of market conditions. Hedge fund managers employ alternative investment strategies to achieve their goals, including long-short equity, market neutral, or absolute return strategies, also known as “all-weather strategies.”

A long-short equity strategy sees the fund manager investing in a company with the potential to appreciate. However, they may also short (or bet against) the company and profit if its value decreases.

A market-neutral strategy reduces risk created by factors like exposure to sectors, market-cap ranges, investment styles, currencies, or countries. All-weather strategies simply invest in more than one asset class to generate returns regardless of how the traditional market performs.

However, the hedge fund industry is highly complex and unavailable to all investors. Only institutional investors like pension funds or a sophisticated investor may invest in hedge funds.

5. Real Estate

Real estate is arguably one of the oldest investments, yet it’s still considered an alternative asset, especially when investing in office or residential properties.

There are several methods for investing in real estate. Investors can simply buy a property outright and benefit from rent payments. Alternatively, for those wanting to invest in a real asset without needing significant capital to purchase property, a real estate investment trust (REIT) is a good option. Both public and private REITs exist. The main difference is that public REITs trade on the stock market.

A REIT is a company that owns, operates, or finances income-producing real estate across various sectors. These investment opportunities allow individual investors to benefit from real estate, an investment class that has historically been reserved for the wealthy.

As with other tangible assets, valuation can be a challenge in real estate investing. Real estate valuation methods, including income capitalization, discounted cash flow, and sales comparable, all have pros and cons.

To be successful in real estate investing, understanding when and how to use the various methods is crucial.

6. Managed Futures

Managed futures is a portfolio of futures contracts actively managed by a fund manager. Much like hedge funds, institutional investors and other funds use managed futures for diversification since managed futures tend to have minimal correlation with traditional markets.

Managed futures are also typically only available to accredited investors as there are considerable fees involved, though less than with hedge funds.

Commodity Trading Advisors (CTAs), money managers specializing in managing futures, use a proprietary trading system or discretionary method that can involve going long or short in futures contracts. Strategies and approaches differ between CTAs, but they often invest in a portfolio of futures contracts consisting of:

Fixed income futures, like US treasury notes
Stock index futures, like the S&P 500 futures
Commodity futures
Foreign currency futures

Alternative Investments: Worthy Additions To Your Portfolio

Every investment strategy should include some alternative investments. They can be lucrative additions while helping to mitigate risk by creating a more diversified portfolio.

However, some of them can be expensive, and not every alternative asset is available to all individual investors.

But, collectibles are one of the most accessible forms of alternative investments, and wine makes for a low-risk investment with steady returns. With Vinovest, investing in the world’s most distinguished wines is easier than ever.