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Alternative assets: things to consider

December 3, 2020
|
Insights
updated on
April 15, 2024

Key Takeaways

  • Alternative assets are non-traditional assets like stocks and bonds that include non-publicly traded assets and are sometimes known as private market alternatives.
  • Alternative assets can help you diversify your investment portfolio and provide increased potential for historically high returns.
  • Investors can use their retirement funds to invest in alternative assets.

What Are Alternative Assets?

Alternative assets are unconventional financial assets that do not conform to traditional investment categories of stocks, bonds, cash, or ETFs.

While many people associate alternative assets with exotic investment options like bottles of fine wine, precious metals, fancy collectible cars,  and even rare coins, it can also apply to relatively common investments like real estate, infrastructure, and hedge funds.

Most alternative assets are illiquid, and many of them have high minimum investments and fee structures. For this reason, they are typically considered significantly more complex investments, and their transaction processes are often far more complicated to navigate.

What are the potential benefits of investing in alternative assets?

Accredited investors* flock to alternative investment strategies for a few reasons:

  • Unconventional assets enable diversification of one’s investment portfolio. A diversified portfolio can be an important consideration for long-term financial goals.
  • Alternative assets offer investors opportunities to capitalize on a hitherto untapped market or asset class, allowing them to potentially improve returns when public equity returns are negative or low.
  • Alternative assets tend to be less impacted by market fluctuations, thereby reducing the negative impact of market volatility.

*Non-accredited investors or retail investors can also invest in alternative assets with some restrictions.

What are the risks of investing in alternative assets?

While alternative assets can assist in the diversification of your portfolio, they have a few drawbacks, too:

  • Most alternative assets are known for their illiquidity, meaning they’re difficult to sell quickly.
  • They are more complex than traditional investments. Investors need to do rigorous due diligence and have a highly sophisticated, deep understanding of the alternative assets they are considering.
  • There are government prohibitions of investing into certain kinds of assets from certain accounts. For example, the IRS prohibits investing in collectibles like stamps and artwork with a self-directed IRA.*
  • For some investments, you may have to rely solely on the investment advice provided by the investment provider-which can have hidden risks.

When it comes to alternative investment management, it’s always a good idea to educate yourself about the assets in which you want to invest. If you have questions about how to use your pension funds and self-directed retirement funds to invest in alternative assets, Alto can help.

*Note that an SDIRA can be used to invest in securitized collectibles and fine art, amongst other similar real asset alternatives.

How to invest in alternative assets

These days, there are quite a few alternative assets that investors can consider when evaluating how best to diversify their portfolios. Here are some of the most common alternative assets to explore.

1. Private Equity

Investing in private equity involves owning a portion of a company that isn’t publicly traded through a PE fund’s capital outlay into the private company. Companies raise capital from private equity funds for a few reasons:

  • Early-stage funding to grow a new business.
  • Later-stage funding to overhaul the structure of an existing, proven business, execute operational changes, accelerate growth, and more
  • Financing an acquisition

Investors contribute to a company through private equity funds or invest directly in private companies using an IRA custodian to finance the company’s goals and aspirations. In return, they’re typically given a stake in the business that can appreciate over time.

Private equity investments grow in value as the company that was invested in does. Investors can then sell their stake for a sum that may far exceed what was invested. However, the returns you get from these investments are dependent on the performance of the company. There’s no guarantee that a company will grow.

2. Hedge Funds

When you invest in a hedge fund, your money is pooled together with other contributions to create a hedge fund’s assets under management.

Like mutual funds in an asset-management firm, these investments are operated by hedge fund managers who invest in different financial assets, such as securities and distressed debt. Unlike private equity, hedge funds only invest in equities in public markets.

Hedge funds include a variety of trading strategies that seek out market inefficiencies. This allows hedge fund managers to add significant value to their investments over time. This, of course, is dependent on the performance of these public equities in the market. While hedge fund managers take an annual maintenance fee from investors, the gains you could potentially make from these funds far exceed what you could earn by trying to invest in the stock market on your own.

3. Peer-to-Peer (P2P) Lending

P2P lending is an alternative method of financing that enables individuals to obtain loans directly from other individuals through online services.

Your main source of revenue through P2P lending is the interest you are owed on the loans you’ve given out.

Individuals typically seek P2P loans when they’ve been turned away from traditional banking routes. In most cases, this is because they have lower credit scores and higher risks of default. To mitigate this, an investor can add a credit score baseline to weed out any loanees who appear at higher risk.

4. Real Assets

Real assets are tangible assets with intrinsic value, such as real estate, fine wine, farmland, fine art, and other similar things. Luxury items and collectibles like vintage cars also fall into this category. As these investments are relatively unaffected by fluctuations in the public market, they can be used to balance your portfolio’s risk.

The value of real assets is directly related to supply and demand. The higher the demand for a scarce physical thing, the greater its value in the market. However, numerous factors can dictate the rise or fall in the value of specific assets. Detailed knowledge of each real asset class and its unique market is essential when trying to gauge price movements.

It’s worth noting that there’s no guarantee that the demand and value for your tangible assets will increase over time. Most tangible assets need to be desired, in good condition, and in low supply for them to appreciate.

The bottom line

Historically, investing in alternative assets has been a time-consuming, complicated and expensive process, often leaving investors confused and frustrated. Alto now makes it easier than ever for individual sophisticated investors to allocate retirement savings to invest in alternative assets with all of their potential benefits.

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