When people think of investments, they usually think of stocks and bonds. But there is a whole world of investments available beyond the traditional asset classes. Most investors aren’t familiar with the many alternative investments available, which means they may be missing out on the benefits these investments can bring to their portfolio.

What Are Alternative Investments?

An alternative investment is an asset that is not one of the standard investment types, such as stocks, bonds, and cash. There is a myriad of alternative investments, with the most common ones being real estate, private equity, hedge funds, commodities, options, and futures.

Alternative investments are commonly held by institutional investors, high net worth and even accredited individuals. This is partially due to their complex structure; however, it is mostly due to regulations surrounding them. That said, some of the more common alternatives such as real estate and certain commodities are widely held and available to most investors.

Some investors choose to add alternative investments to their portfolio to diversify their portfolio and reduce risk.

The Cons of Alternative of Investments

Before we dive into the potential benefits of alternative investments, let’s look at the downside of using them. Personally, I believe they have a place in some investors’ portfolios, but they are not necessarily beneficial for everyone, nor are they ideal for risk-averse investors.

• Most alternative investments are not as liquid as traditional securities, so it can be more difficult to sell those shares due to a more limited number of potential buyers. This can result in longer hold periods than an investor may be comfortable with. Other reasons include the fact that most alternatives are valuated on monthly basis and therefore an investor needs to wait out the month before cashing out.
• Alternative investments can be less transparent than conventional investments. The reasons are that there may be less information available for these investments and that they are at times complex to describe even to the astute investor, resulting in a broader stroke commentary within statements and performance reports.
• Alternative investments can have higher upfront investment fees than other assets, as a built in risk ‘safety measure’ as well as a higher initial investment ticket, often ranging from $250,000 to $25 million (though it can be as low as $25,000 and as high as $100 million).
• Falling under a broad range of regulators, and therefore as little disjointed, alternatives can and have been susceptible to fraud and investment scams. For this reason, it is imperative to conduct extensive due diligence or work with an experienced investment professional before investing.
• Some alternative investments can be volatile, leading to more stringent regulations. You could potentially risk a substantial part or even all of your capital, since the underlying investment vehicles do not generally fit into the traditional investment class types. It is typical to find underlying vehicles such as commodities, futures, options, and to a certain extent, any asset that can be charted, traded, or that matures at a certain time in the future.

The Pros of Alternative Investments

While there are some downsides to alternative investments, there are also multiple upsides that may be appropriate for some portfolios.

• You are in it for the long hull, meaning, that you will not have the luxury or temptation to trade in and out of these alternative investments. Believe it or not, they are meant to be held through thick and thin so that the maximum potential can be realized.
• While alternative investments can have higher upfront costs, they often have lower transaction costs if they’re held for a long period of time.
• Alternative investments can offer tax benefits. As these assets are usually held over a longer period of time (more than 12 months), they may be subject to a lower capital gains tax.
• In my opinion, the feature benefit that alternative investments offer is a very low correlation with standard asset classes, which can smooth portfolio volatility and overall drawdowns when markets have periodic corrections. As hard assets have an inverse relationship with stocks and bonds, they can help hedge against rising inflation. By including alternative assets in your portfolio, you can more broadly diversify your portfolio, reduce risk, and increase returns.
• The historical compounded rates of return and performance are quite impressive when compared to staple indices such as the S&P 500 or even the Dow Jones Industrial Average.
• With alternative investments, you can gain access to instruments called ‘fund of hedge funds’ which offer an extra layer of risk aversion when investing in alternatives. Through these investment strategies, an investor holds a basket or pool of alternative investments instead of investing directly in commodities, futures, and option etc. This can be one way to reduce volatility, in other words reduce risk, and diversify your portfolio as you are not putting all of your allotted cash into one alternative investment. Additionally, through a pooled structure, you have an opportunity to gain access to investments that would normally be far out of reach.

Are Alternative Investments Right For You?

Most alternative investments are complex by nature and widely regulated, so it is important to work with a knowledgeable financial professional to help you understand if they make sense for your portfolio and if you should invest in them. ;.

About Gino

Gino Scialdone is a financial advisor and the owner of Black Spruce Financial, an independent wealth management firm serving independent business owners. Having grown up in a family business and owning a business himself, Gino has a unique understanding of the challenges and needs business owners face. Offering a comprehensive array of wealth management and financial planning services, he strives to provide sound and creative strategies that meet a business owner’s short and long-term needs. Based in Toronto, Gino serves clients throughout the greater Toronto area and southern Ontario. To learn more, connect with him on LinkedIn or visit www.blacksprucefinancial.com.