Alternative Assets: The Beginners Guide

The alternative assets industry is expected to reach $14 trillion by 2023. Surprised? Don’t be.

Given the current volatility in the financial markets due to escalating US-China trade wars and uncertainty surrounding the Federal Reserve’s interest rate policy, it is no wonder that investors are seeking alternative investments to diversify some of that risk. A steady decline in publicly traded companies combined with investors’ need for higher returns is one of the biggest factors fueling the popularity of alternative assets. In this post, we will cover:

1. What are alternative assets?
2. Why are alternative assets In demand?
3. Disadvantages of investing in alternative assets
4. Popular alternative asset investments
5. How to invest in alternative assets

Ready to find out if this asset class should be part of your investment strategies? Let’s go.

What Are Alternative Assets?

Alternative assets are unconventional financial assets that do not conform to traditional investment categories of stocks, bonds, or ETFs. While most of you may associate alternative assets with exotic investment options like bottles of fine wine, precious metals or 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.

Why Are Alternative Assets In Demand?

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

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

However, it’s not just accredited individuals. Non-accredited, or retail, investors can also invest in alternative assets with some restrictions.

Read more: What Is an Accredited Investor and How Do I Become One?

Disadvantages 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 not known for their liquidity, which makes it difficult to sell the investments quickly when you need cash.
• They are more complex than traditional investments. Therefore investors need to do better due diligence and have a deeper understanding of the assets they are investing in.
• There are government prohibitions over investing in 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 you want to invest in. If you have questions about how to use your pension funds and self-directed retirement funds to invest in alternative assets, a custodian like Alto can help.

Popular Alternative Asset Investments

1. Private Equity

Investing in private equity involves owning a portion of a company that isn’t publicly traded. Companies raise capital from private equity funds for a few reasons:

• Early stage funding to grow a new business (venture capital)
• Rehauling the structure of the business and executing operational changes
• Financing an acquisition

Investors contribute to a company through private equity funds or invest directly using an IRA custodian to finance the company’s goals and aspirations. In return, they’re often given a stake of the business that can appreciate over time. Some of the crowdfunding platforms where you can directly invest in private equity include Republic (for non-accredited investors) and AngelList (for accredited investors).

How You Make Money

Private equity investments become valuable once the company starts to grow and appreciate. The valuation of your stake in the company will grow provided the business continues to grow at a steady rate. Investors can then sell their stake for a sum that far exceeds what they invested.

Risk Involved

Unlike public investments, private equity is relatively unaffected by market volatility and price changes. 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. It’s a high-return but high-risk investment.

Read more: What’s the Difference Between Private Equity and Venture Capital?

2. Hedge Funds

Hedge funds are one of the six types of institutional investors. 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 it in different financial assets such as securities and distressed debt. Unlike private equity, hedge funds only invest in equities in public markets.

How You Make Money

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.

Risk Involved

Market volatility always plays a role in any publicly traded equity. Successfully predicting the trajectory of a stock’s value over time is no easy task and can flummox even the most experienced hedge fund managers. Hedge funds are very much a high risk-high return investment where you could make or lose millions in minutes.

3. P2P Lending

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

How You Make Money

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

Risk Involved

Individuals seek P2P loans when they’ve been turned away from traditional banking routes. In most cases, this is because they have a lower credit score and a higher risk of default. To mitigate this risk, you can add a credit score baseline to weed out any loanees you’re uncomfortable loaning to.

4. Real Assets

Real assets are tangible assets with intrinsic value such as real estate, oil, racehorses, etc. Luxury items and collectibles such as art and 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.

How You Make Money

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

Risk Involved

There’s no guarantee that the demand and value for your tangible assets will increase over time. Often this can be a hard figure to predict due to the numerous forces that affect the value of such a commodity. For example, most tangible assets need to be desired, in good condition and low supply for them to appreciate. Trying to satisfy all three conditions can be difficult, resulting in a subpar return from your investment. Additionally, most tangible assets are illiquid-making it harder to cash in on them.

Read more: How Much Do You Need to Invest in Real Estate? Less Than You May Think

How to Invest in Alternative Assets

Historically, investing in alternative assets has been a time-consuming, complicated, and expensive process. However, with a custodian like Alto, it is now easier, faster, and cheaper to use your IRA savings to invest in alternative assets. It is easier to manage your IRA funds with a custodian as it holds title to your assets for your benefit and is responsible for IRS reporting.

Alto lets you diversify your IRA investments portfolio by investing in startups, real estate, loans and more through partner investment platforms such as AngelList, Silicon Prairie, and more. 

What’s more? Alto is 100% online so you can get started right away.