Traders and investors are increasingly turning to alternative investment options to diversify their portfolios and seek new avenues for potential returns. In this FXOpen article, we discuss alternative investments, examining the types and explaining the reasons why they are gaining traction.

What Is an Alternative Investment?

Alternative investments deviate from conventional stocks, bonds, and cash, presenting investors with a diverse range of opportunities characterised by the nature of the assets and the unique market dynamics they inhabit. These alternatives can be broadly classified into tangible assets like real estate and art and intangible assets such as private equity, hedge funds, and cryptocurrencies*. This dual categorisation introduces a distinctive dimension to portfolio construction, allowing investors to strategically blend tangible and intangible assets for a well-balanced and diversified investment strategy.

In contrast to traditional investments traded on public exchanges with comprehensive regulatory oversight, which typically offer lower volatility and moderate returns, alternative investments, operating in less liquid markets, hold the potential for higher returns but require specialised knowledge and careful attention to regulatory considerations, contributing to their increased complexity and risk.

Alternative Investment Types

For each alternative investment type, investors must consider their personal investment objectives and risk tolerance, as each of the assets discussed below has its specifics.

Real Estate

Real estate is a tangible alternative investment class, providing investors with exposure to potential price appreciation and a steady rental income, whether through direct ownership or Real Estate Investment Trusts (REITs). Real estate investments necessitate a long-term outlook, require significant upfront capital, and are also susceptible to market conditions.

Private Equity

Private equity entails investing in private companies not listed on public stock exchanges, with diverse investment options such as venture capital, buyouts, and direct investments in private firms. This investment class is characterised by a longer investment horizon, allowing active involvement in the growth of the invested companies. Considerations include high barriers to entry due to larger investment commitments and the necessity for specific expertise.

Hedge Funds

Hedge funds are investment funds employing diverse strategies, such as long-short equity, macroeconomic bets and high leverage and derivatives trading to generate returns. Notably, these funds often aim for absolute returns regardless of prevailing market conditions. Hedge fund investments are often associated with higher fees compared to traditional investment funds. Also, investors need to understand and monitor the diverse range of strategies employed by these funds.

Commodities

Commodities encompass tangible assets with intrinsic value, such as precious metals, agricultural products, and energy resources. Commodity prices are influenced by supply and demand dynamics and are mostly used as a hedge against inflation and geopolitical risks. Commodities offer limited returns compared to other assets, while the necessity for physical storage in some cases can be a major disadvantage.

Art and Collectables

This alternative investment class involves acquiring unique and valuable items, such as art, antiques, and rare collectables. Returns are often linked to the appreciation of these items' cultural or historical significance, though valuation can be subjective and influenced by trends. Major considerations are the difficulty in valuing items, the susceptibility to changing trends and tastes, and the requirement for expertise in the specific market.

Cryptocurrencies*

Cryptocurrencies* are digital or virtual assets that utilise cryptography and blockchain technology, with notable examples being Bitcoin and Ethereum. The potential long-term benefits of investing in cryptocurrencies* often hinge on their transaction transparency, decentralised nature, and borderless markets, offering advantages in terms of financial inclusion and accessibility. However, it's crucial to acknowledge potential challenges, such as regulatory uncertainty and cybersecurity issues, that can impact the overall risk and viability of cryptocurrency* investments.

Peer-to-Peer Lending

Peer-to-peer lending utilises online platforms to connect borrowers directly with individual lenders, facilitating loans without traditional financial intermediaries. Returns are generated through interest payments. The potential benefits encompass the advantage of direct lending without the need for a banking intermediary. Considerations involve default risks on loans and a lack of regulatory oversight compared to traditional financial institutions.

Reasons to Consider Alternative Investment Options

Alternative investments exhibit lower correlations with each other, which mitigates the impact of downturns in specific market sectors, reducing overall portfolio volatility.

Alternative assets present opportunities for potential returns, surpassing those of traditional investments.

Another valuable feature is the inconsistent correlation of alternative investments with traditional assets like stocks and bonds, offering independence and strategic advantages during market turbulence.

Furthermore, commodities and real estate have historically demonstrated resilience against the erosive effects of inflation, serving as effective hedges and preserving wealth in inflationary environments.

Alternative investments can thus contribute to an enhanced risk-adjusted return for a portfolio. By strategically incorporating assets that respond differently to market conditions, investors may achieve a more efficient balance between risk and reward. This nuanced approach to portfolio construction aims to maximise returns for a given level of risk tolerance.

Risks and Challenges

While alternative investments offer unique opportunities, there are also inherent complexities.

• Illiquidity stands out as a prominent risk, particularly in assets like real estate, private equity, and certain hedge funds, where longer holding periods hinder the swift conversion to cash. This limitation may impede timely responses to market changes or the exploitation of emerging opportunities.
• The heightened level of complexity of alternative assets demands a sophisticated understanding of strategies, valuations, and market nuances. Successful navigation of this complexity requires ongoing education and engagement.
• Increased market volatility is another issue to consider, exemplified by significant price swings in cryptocurrencies* and distinct volatility in hedge fund strategies.

In alternative investments, thorough due diligence involves researching each asset class, rigorously evaluating fund or investment managers, and maintaining a robust risk management framework with clear parameters, regular portfolio monitoring, and contingency plans for unforeseen events.

Conclusion

Alternative investments offer a compelling avenue for diversification and potential returns. While not without risks, the unique characteristics of alternative assets make them a valuable addition to a well-balanced investment portfolio. However, if you want to stick to traditional markets, you can trade forex or use derivatives to enter stock, commodity, and cryptocurrency* markets. Open an FXOpen account and try out the possibilities on the free trading platform, TickTrader.

*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.

This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.