In 2020, there was a wide range of societal challenges and, as a result, conventional stock and bond markets experienced their share of difficulties.
For many reasons, these markets were particularly volatile last year. Accordingly, there is a growing interest in the viability of alternative investments.
Many people have success with alternative investments, but they are not right for every investor. For instance, it can be difficult for average individuals to gain access to these investment opportunities.
Traditionally, alternative investments were only available to high-net-worth investors or organizations. These high-value operators can invest in securities that are not registered with market regulators. The good news is that fintech companies are swiftly upending some of these restrictions.
In this article, we will examine many common issues surrounding alternative investments. We will explore the advantages and disadvantages of these investments and discuss how digital platforms are making these opportunities more accessible.
Understanding Alternative Investments
Alternative investments involve leveraging assets outside of the traditional markets. Stakeholders often choose to invest in alternatives to diversify their portfolios.
Over time, investors have come to learn that some alternative assets tend to have larger returns than stocks in the public equity markets, with the understanding that those larger returns come with larger risks. This makes access to these alternative investments potentially very valuable.
Some of the most common examples of alternative investments include:
- Private equity
- Private debt investments
- Venture capital
- Real estate investments
- Commodities
- Hedge funds
Many of these asset classes do not correlate highly with stock market performance. In fact, some of these asset classes actually perform better when traditional equity returns are low.
There are several reasons that only certain investors can access alternative asset classes. First, alternative assets require investors to lock up funds for years. This type of investment can result in illiquidity for between five and ten years.
This has effects on an investor’s ability to buy and sell holdings. It also involves postponing the money that is distributed from those investments.
Who Can Purchase Alternative Assets?
Traditionally, there were two types of investors who could access alternative investments: Qualified purchasers and accredited investors.
To qualify as an accredited investor, you must have an income of over $200,000 as an individual. The joint income (with a spouse or spousal equivalent) requirement is $300,000.
These investors must show a two-year income at the required level. Accredited investors can also show a joint net worth of more than $1,000,000 to access alternative investment opportunities.
Qualified purchasers need to have a portfolio totaling $5,000,000 or more. These individuals tend to have access to top-quality investment information or financial advisors. Qualified purchasers are considered to have a sophisticated understanding of investment principles.
How Average Investors Can Access Alternative Investments
Recently, groundbreaking platforms like Yieldstreet have been helping individuals to access alternative investments in commercial, real estate, and legal portfolios. Diversification resulting from investing in alternatives has the potential to provide investors with market independence and wealth-building opportunities. These are the kind of opportunities that were previously unavailable to most people.
Regulatory Oversight of Alternative Investments
Alternative investments generally are subject to fewer regulatory safeguards than traditional markets. Stocks, mutual funds, and bond markets fall under the Investment Company Act of 1940.
This Act mitigates many market conditions that threaten to harm the public and also serves to protect the interest of investors.
Alternative asset markets are not subject to these regulations, entailing more risk for investors. The Investment Company Act applies private-placement exemptions to qualified purchasers and accredited investors.
This framework allows fund managers to sell to qualified investors. In doing so, they can bypass the normal market safeguards. These exemptions allow managers to avoid certain disclosure requirements, for example.
Alternative asset fund managers do not have to report:
- Daily net asset value
- Prospectuses
- Daily holdings statements
Those who invest in alternative assets may receive quarterly data. But this type of information is often delayed, and there is less disclosure on the part of fund managers.
Advantages and Disadvantages
Alternative investments provide certain potential advantages, including:
Diversification
Diversifying your portfolio with alternative assets offers a typically low correlation with traditional markets. It is important to note that a low correlation is not the same as no correlation or a negative correlation. There is no guarantee that alternative investments will boast higher returns when other markets are down.
Unique Opportunities
The unique investments provided by alternative markets can sometimes result in higher returns. This is due to their illiquidity and higher long-term risk.
There are also downsides to alternative investments. These include:
- Long lock-up periods
- Illiquidity
- Complexity
- Higher fees
- More risk
While alternative investments have garnered recent interest, they are not right for everyone.
