Alternative investments Types
Although they have always held the fascination of investors, alternative investments seem to be gaining popularity in recent years as both individuals and institutions look for ways to change their volatility exposure and potentially generate surplus returns beyond holding stocks and bonds.
From cryptocurrencies to mineral rights, structured settlements to timberland, tax lien certificates to cell tower leases, alternative investments can be a compelling choice for the right investor, under the right circumstances.
What Is an Alternative Investment or Alternative Asset?
To appreciate how alternative assets are defined, you need to understand two related concepts known as asset classes and asset allocation. Put simply, an asset class is a type of asset that has a certain set of similar characteristics.
Traditionally, there are a handful of what you might call “core” asset classes that a reasonable person might consider adding to his or her investment portfolio. They include:
Cash and cash equivalents
Why does that matter? In its broadest sense, an alternative investment, or alternative asset, is any type of asset that does not fall into one of these categories. That is, an alternative investment is anything not made up of cash, stocks, or bonds.
What Are Some Examples of Alternative Investments or Alternative Assets?
While the list of alternative investments is extensive, some of the ones you might encounter in the real world include, but are not necessarily limited to, the following:
Real estate and all of its many derivations including directly-owned property, real estate limited partnerships, real estate development corporations, and REITs
Master limited partnerships, which can own and operate everything from oil pipelines to capital-intensive theme parks
Tax lien certificates
Stock or membership units in a privately held business
Commodities, including precious metals such as gold, silver, platinum, and palladium, as well as crude oil, natural gas, ethanol, corn, soybeans, wheat, cocoa, coffee, sugar, and many other items.
Intellectual property such as copyrights, song rights, patents, and trademarks
Privately underwritten mortgages
Art and collectibles
Coins that have numismatic value
Why Do Investors Seek Out Alternative Investments or Alternative Assets?
There are several reasons an investor or a portfolio manager is likely to consider adding alternative investments to the balance sheet.
In some cases, money generated from an alternative investment might be subject to far more favorable tax treatment than that from a more traditional investment; e.g., if an investor or client has significant tax-loss carryforwards or tax credits that can be applied to a particular type of activity or source of income.
In other cases, factors and conditions specific to that particular asset class at the time the investment is considered might make the asset class appear significantly cheaper, and thus more attractive for a long-term owner, than other types of investments available in the market. For example, there was a period during the aftermath of the Great Recession when wealthy investors were buying deeply discounted condos in cities such as Miami, paying a fraction of what they thought the ultimate market value would be in the future.
Sometimes, the investor or his or her advisors have a deep knowledge or unique skill set in a specific area that can cause alternative investments to make sense. For example, if an experienced entrepreneur in the oil and gas industry had the resources and patience to take advantage of a major oil and/or gas glut, that unique knowledge and experience might pay off handsomely.
In other situations, a particular alternative investment or alternative asset class might emotionally and intellectually hold the attention of the investor more than other asset classes. For example, there are successful investors who are deeply drawn to venture capital because they enjoy the process of identifying, funding, and taking ownership in startups and relatively new enterprises; to see them grow and prosper, knowing they were part of it.
There are some investors, particularly those who are older, who do not like owning stocks and bonds, preferring to underwrite their own mortgages on real estate properties they have acquired and renovated. It makes sense to them. They feel that they can better understand the potential gains and losses, especially when compared to the daily volatility that is part and parcel of owning publicly-traded common stock.
There are some investors who acquire catalogs of music rights, either at auction, in negotiated transactions, or through bankruptcy court proceedings because they understand how to administer and license those rights to interested parties. Arguably among the most famous alternative investors are so-called “Gold Bugs” who hoard gold bullion in coin and bar form. For many who fall into this camp, gold becomes almost an obsession that often doesn’t seem entirely rational to those who don’t feel the same compulsion to amass the legendary metal.
XIO Group is a global multi-billion dollar alternative investments firm headquartered in London, United Kingdom. XIO Group’s strategy is to identify and invest in market-leading and high-performing businesses located across Europe and North America and to partner with management to help these companies in capitalizing on untapped opportunities in fast growing markets, particularly those in Asia. XIO Group has operations in the United Kingdom, Germany, Switzerland, Israel, Hong Kong, Mainland China and the United States of America.
The Benefits of Alternative Investments
the potential benefits of alternative investments — tax-advantaged or sheltered cash flows under certain circumstances, less efficient markets that can lead to exploitable opportunities, intellectual and emotional satisfaction when dealing with an asset the investors likes, understands, and feels he or she has a competitive or strategic leg up on the competition. So it’s probably best to focus on the negatives, of which there are many.
1) Mitigate Market Volatility
Alternative assets often cushion market volatility present in more traditional investments like those found in the public markets. This is accomplished by investing in asset classes like private equity fund that feature low correlation to the markets.
Investors all too often have the tendency to react hastily when markets turn sour as they generally lack the ability to fully understand the underlying causes of this volatility. The long lock-up periods of alternative investments reduce preemptive reactions to risk and create a natural hedge against the myopic knee-jerk reactions of the average investor. Fear-based selling and behavioral investing are tempered by the illiquidity present in many alternative investments.
2) Lower Transaction Costs
Short-term investing often requires high amounts of turnover, leading to the creation of high transaction costs. While short-term investing sometimes yield high returns, many of these benefits are offset by the costs associated with maintaining and rebalancing a portfolio. It is often difficult to create a model to generate an efficient portfolio for maximized returns while limiting high transaction costs.
Alternative investments often have higher upfront fees compared to other traditional investments, but this is ameliorated by the fact that these investments are typically not subject to high turnover and ongoing maintenance and transaction costs.
3) Tax Benefits
While not unique to alternative investments, long-term investments (longer than 12 months) have certain tax benefits. These longer-term investments are subject to long-term capital gains tax, which is lower than the taxes incurred from short-term investments. Additionally, capital gains tax is generally only incurred upon realized gains. As a result of the longer holding periods of illiquid alternatives, these investments may hedge against short-term capital gains taxes. Consult with your financial consultant and/or tax advisor in order to determine which investments may be best suited for your portfolio and long-term investment strategy.