The Surprising Truth about Alternative Investments

Do I need to invest in Alternative Investments?

Are alternative investments for me?

In the world of sports, the weightlifter will assess the weight to be lifted vis-à-vis his capacity and strength; a diver will measure the depth and nature of water before taking the plunge.

This analogy can be extended to the field of investment also.

Every investor has to make an assessment as to the risks he will shoulder while making an investment.

The individual’s propensity to take risks will define the class of investment which he would prefer to invest in.

Table of Contents:

1.) What are Alternative Investments?

2.) Structured Investment Products

3.) Why Do Investors Consider Alternative Investments?

4.) Who Should Consider Alternative Investments?

5.) Risk Involved in Alternative Investments

6.) How Much Should You Allocate to Alternative Investments?

7.) Common Mistakes Investors Make with Alternative Investments

8.) Final Verdict on Alternative Investments

1. What are Alternative Investments?

Are you curious about alternative investments and their role in diversifying your portfolio?

Alternative investments encompass a diverse range of assets beyond traditional stocks and bonds.

Alternative investment products can play a complementary role alongside traditional investments, helping experienced investors access opportunities that are often unavailable through conventional equity or debt markets.

These investments offer unique opportunities for investors seeking to spread risk and potentially enhance returns.

So, what exactly are alternative investments?

Alternative investments are non-traditional assets that can include real estate, commodities, hedge funds, private equity, cryptocurrencies, and more.

Other than the conventional forms of investment like bonds and shares, investors may often explore non-conventional areas for investment, like structured investment product, venture capital, equity crowd funding, rare coins, stamps, forestry and art.

All these options are generically termed as ‘alternative investments’.

From private equity and venture capital to real estate, commodities and collectibles, the list of alternative assets continues to expand as investors look beyond conventional investment alternatives for diversification and long-term wealth creation.

These assets often have low correlation with traditional markets, making them attractive options for diversification.

One of the defining characteristics of alternative asset investments is that their performance may be driven by factors different from those influencing stock or bond markets, making them useful portfolio diversifiers when used judiciously.

Despite their unconventional nature, alternative investments have gained popularity among investors looking to mitigate risk and explore new avenues for growth.

Stay tuned as we explore the surprising truth about alternative investments and how they can complement your investment strategy.

2. Structured Investment Products

Among the different alternative investments, structured investment products are more popular in India.

Structured products are mostly market linked.

These products are pre-packaged with well-defined investment strategies.

They pre-package and structure the product based on derivatives, index, foreign currencies, debt instruments and the like.

Structured investment products are launched with or without capital protection theme.

Structured investment products are only one category within the broader universe of alternative investments.

Before investing, it is essential to understand how the product generates returns, whether capital protection exists, and the risks involved under different market conditions.

3. Why do investors consider alternative investments?

• Investors may find that the returns from conventional modes not yielding the expected returns and could hence venture into the world of alternative investments. Investors expect that the alternative investments will give better return than the conventional risky asset class like equity.
• Some investors consider alternative investments because they get bored with regular equity investments. They need variety.
• Some other investors consider alternative investments because they enjoy the thrill it gives.

Do you think the above reasons sound reasonable?

4. Who Should Consider Alternative Investments?

Alternative investing is generally more suitable for investors who already have a well-diversified portfolio of traditional investments and are looking to allocate only a limited portion of their wealth to alternative assets.

Beginners should first build a strong investment foundation before exploring alternative investment categories.

5. Risk involved in Alternative Investments

It is alright to take a detour, and test the water of alternative investment; however, the investor has to get a measure of the depth of the water in the pool.

It is important to make an objective assessment as to the risks associated with the particular investment type and what could be the expected prospect of returns from the investment type.

Here we analyze the various risk forms of alternative so that investors can make a knowledgeable judgment on the same.

Let us look into the specific nature of risks associated with alternative investments:

i. Alternative investments are less researched

Alternative investments are less researched in comparison to conventional investments and this makes it difficult for an investor to make informed judgements.

Lack of adequate information and knowledge can be a road block in the proper assessment of the associated risks.

Operational and organizational risk analyses are a pre-condition to risk management, however lack of knowledge impedes such an analysis.

It is possible that while investing in a tree within a plantation, the investor might be unaware of the soil characteristics and the environmental issues around the plantation.

This would make it difficult to make an objective assessment of the risks involved in such an investment.

ii. Alternative investments are illiquid

Many alternative investments, such as private equity and real estate, lack liquidity compared to traditional assets like stocks and bonds.

Liquidity risk varies significantly across different types of alternative investments.

While exchange-traded products may offer relatively easy exit options, investments such as private equity, collectibles, or unlisted assets can remain locked in for several years.

Selling these investments may take time and could result in significant losses if immediate liquidity is needed.

More often than not it is difficult to sell alternative investments when liquid funds are needed.

For example, it would be difficult to find a buyer overnight for alternative investments like rare coins or stamps.

Where ever possible, alternative investment options should be examined for initial due diligence and monitoring so that the liquidity position can be assessed.

iii. No proper price discovery mechanism for alternative investments

Since the options for alternative investment are unconventional, the methodology of their valuation is not easy and transparent.

Unlike listed securities that trade daily on exchanges, many alternative assets rely on independent valuations, negotiated prices, or periodic appraisals, making fair value assessment considerably more challenging.

While bonds and shares follow a clear valuation norm there is ambiguity in valuation of alternative investments like a piece of art or property in a foreign country.

However, market linked alternative investments are comparatively not difficult to value.

iv. Alternative investments and volatility

Alternative investments with the aim of capital protection are less volatile.

Similarly, alternative investments based on debt instruments are also less volatile.

However, aggressive alternative investments are more volatile and could behave in an unpredictable manner.

This could lead investors to lose money without hope for recovery in the long run.

The investor is unaware as to how the market could evolve in the future.

Being unconventional in nature, the alternative investment option could turn out to be erratic and could lead the liquidity aspect of investment to be affected.

v. Alternative investments and scams

Gullible investors may be conned by people involved in scams by projecting quick and high returns through the alternative investments route.

As there is no regulatory body to regulate these alternative investments, the probability of scams in alternative investments goes up.

vi. Alternative investments are Complex

Alternative investments often involve complex structures and strategies that may be challenging for average investors to understand.

Understanding the structure, taxation, exit conditions, and underlying assets is just as important as evaluating expected returns.

Complexity itself can become an investment risk when investors purchase products they do not fully understand.

Without proper knowledge or guidance, investors may face difficulty navigating these complexities effectively.

vii. Alternative Investments are Riskier:

Alternative investments typically carry higher levels of risk compared to traditional assets.

Factors such as leverage, market volatility, and regulatory uncertainties can amplify the risk associated with these investments.

viii. Alternative Investments Are Less Transparent

Unlike publicly traded securities, alternative investments may offer limited transparency into their underlying assets and performance.

This lack of transparency can make it difficult for investors to assess the true value and risk of their investments.

ix. Alternative Investments Have Higher Fees

Alternative investments often come with higher fees and expenses compared to traditional assets.

These fees can erode returns over time, especially if the investment underperforms or fails to meet expectations.

6. How Much Should You Allocate to Alternative Investments?

Even sophisticated investors typically treat alternative assets as a satellite allocation rather than the core of their portfolio.

The appropriate exposure depends on your financial goals, liquidity needs, investment horizon, and ability to withstand risk.

7. Common Mistakes Investors Make with Alternative Investments

Many investors enter alternative investments expecting superior returns without fully understanding the underlying risks.

Chasing trends, overlooking liquidity constraints, ignoring fees, and investing without adequate due diligence are among the most common mistakes that reduce long-term investment outcomes.

8. Final Verdict on Alternative investments

Just because, you want more returns, alternative investments are not likely to give better returns than well managed equity funds.

Successful investment needs discipline and patience.

If you want variety and thrill, you can go to movies or casinos.

Avoid investing in alternative investments by taking blind risk. Encourage investing in well managed equity funds by taking calculated risk.

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