The traditional types of investments are cash, bonds and stocks. Previously, the only alternatives to these were real estate, commodities and private equity. Recently, however, various types of strategies that give different methods of returns (from the traditional and “old” alternatives) have also come to be categorized as alternative investments, albeit “newer” alternatives. These strategies (or new alternatives) are the hedge funds, managed funds and derivatives.
Previously, real estate investments were mostly homes, rentals, lots and raw land, until buildings, malls, condominiums and (more recently) real estate investment trusts got into the picture. Investments in commodities, without taking physical control of these, also developed from the days when evidence of physical availability had to be present. Equity investments in unlisted companies became popular with the advent of venture capitalism, in anticipation that success of these companies would result in value appreciation and subsequent listing.
Hedge funds are funds allowed by regulators to invest in more investment types (stocks, bonds, commodities, currencies) through more tools (short selling, leverage) than ordinary funds. Managed funds are like mutual funds but are allowed long or short positions in commodity and currency futures contracts, and options in such contracts. Derivatives (like call or put options, future contracts, convertible bonds or stocks) are contracts, securities or financial instruments whose values derive from values of traditional investments (e.g., stocks) or assets (e.g., gold).
Alternative investments were all previously considered speculative. Now most real estate transactions are considered sound investments, and even the new alternatives are considered sound investments by big pension funds. The advent of good professional fund managers and their proven analytical tools account for this confidence in the new alternatives among bigger investors. This confidence, however, has been eroded somewhat by the recent stock market debacle being attributed to derivatives and the greed of financial managers.
Alternative investments are generally less liquid than the traditional since they have no secondary market. Returns are not only more risky, but more volatile. There are also often transfer restrictions. There is normally less information as to the values and the prices of these investments. Fees charged by managers and minimum investment requirements are higher, and there is less regulation from government, giving investors less protection.
Investors in the New Alternatives
Alternative investments can provide more returns, in conformity with the precept of “more risks, more return." Being high-risk, these are not suitable for all types of investors but are meant more for the sophisticated and experienced. With a desire for higher returns and more diversification and with a higher-risk appetite, individuals with high net worth and institutional investors are the clientele for these types of investments, even if pension funds invest only small portions of their portfolio in these.