What is an Alternative Investment?
An alternative investment is an investment in assets different from cash, stocks, and bonds. Alternative investments can be investments in tangible assets such as precious metals or wine. In addition, they can be investments in financial assets such as private equity, distressed securities, and hedge funds.
Generally, alternative investments tend to show a low correlation with traditional investments (stocks, bonds). In addition, some alternative investments come with extremely complicated valuation and are highly illiquid. Due to such reasons, certain types of alternative investments are quite popular among financial institutions and high net worth individuals.
Alternative investments may be a great addition to an investor’s portfolio. Many alternative investments provide significantly greater returns relative to traditional investments. Also, the availability of a wide range of alternative investments makes them a viable option despite the investor’s risk tolerance or perceptions of the market.
Features of Alternative Investments
Almost all alternative investments come with the following features that distinguish them from traditional forms of investment:
1. Low correlation with the traditional investments
This may be extremely beneficial to potential investors because the low correlation provides opportunities for portfolio diversification.
2. Hard to determine the underlying value
Alternative investments are often inherently complicated when it comes to valuation. The valuation of an alternative investment may require specific knowledge, and some exotic investments, such as fine art, may show unpredictable demand patterns. In addition, they may be unique in their nature, which also complicates the valuation.
3. Relatively low liquidity
Generally, alternative investments possess relatively low liquidity, especially compared to traditional investments. The low liquidity can be explained by the absence of centralized markets and the low demand for some of the assets relative to traditional investments (think about works of contemporary art). In addition, some of the investments come with restrictions regarding exiting from the investment.
4. High purchasing costs
Alternative investments are frequently associated with high purchasing costs. Some alternative investments such as hedge funds require a minimum investment amount, as well as a fee.
Classification of Alternative Investments
Alternative investments may be classified as tangible or intangible investments.
Tangible alternative investments include the following:
- Precious metals
- Fine art
Examples of intangible alternative investments include:
- Hedge funds
- Private equity
- Venture capital
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: