Derek, what are alternative investments?
Traditionally investors think of investment choices as stocks, bonds, or cash. However, with recent volatility in the stock market and low interest rates some are asking if there are any other options to consider. One often unexplored area is that of alternative investments.
The term “alternative investments” covers a large basket of strategies that go beyond just stocks and bonds. This investment strategy is split into four possible categories, which are: real assets, hedge funds, private equity, and structured products.
Real assets include investments that you could physically touch, so to speak. This category includes investments in real estate, commodities (like a bushel of wheat or barrel of oil), infrastructure (such as toll bridges), and intellectual property (such as copyrights and trademarks). Unlike buying a stock where a company’s profits are determined by the price of a commodity, you could physically take ownership of a commodity. While most of us don’t want to have a barrel of oil in our backyard, we could consider to profit on the price changes via the futures market. In any case, the point of owing real assets is to help diversify your stock and bond portfolio.
The next category is that of hedge funds. These investment strategies are often wrongly considered to have a high level of risk with the potential to lose everything. While this may be true with certain types of hedge funds, there are a number of complex strategies which can be considered low risk and nearly no risk. In most cases, these funds are structured as private limited partnerships, require a high minimum investment, and tend to be illiquid. The strategies employed by the investment teams at hedge funds tend to focus on achieving positive returns regardless of market conditions. This can be accomplished using leverage, short selling, and derivatives. In any case, the strategies are often complex and need to be fully understood prior to investing.
Private equity is a viable option for alternative investing, but can be difficult to attain. Simply put, private equity are companies who do not have debt or equity trading on a public stock exchange. This could be as simple as your locally owned hardware store, to as complicated as investing in tech start-up, or even a massive international company whose shares are privately owned. Generally speaking this category is what we think of as venture capital; a new company seeking investors to help grow their business and eventually go public. Otherwise, it could be taking ownership in a failing company, improving their financial performance, and selling it for a profit. In any case, these companies are not listed on an exchange and therefore considered to be private equity.
Lastly there are structured products. This category can be quite broad in definition, but typically involves an investment product that was created to achieve a certain objective either in terms or risk, return, or taxation. One example would be a bond or a note that provides a fixed rate of return according to the future performance of an index or commodity. If that index or commodity doesn’t reach the level indicated, there is no return. If it does, there is a fixed rate of return paid on the investment. Common structured products include Principal Protected Notes (PPN) and Principal at Risk Notes (PAR). In any case, they are often structured using derivatives.
The point of alternative investments is to enhance diversification, reduce risk, but not sacrifice returns. Studies have shown that adding alternative investments to a portfolio is an effective way to achieve lower risk, and roughly equivalent returns. While this statement requires more discussion, the general consideration is that adding alternative investments to your investment strategy may be an effective strategy.
What you’re ultimately trying to achieve is to balance the risks from the stock and bond markets with something that may not be fully influenced by those same markets. By doing so properly you may have achieved better diversification and ideally less risk. Prior to acting on the information in this article, I would strongly recommend that you speak to qualified Wealth Advisor about the benefits and risks of alternative investments.
This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article. The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. Scotia Wealth Management is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.
Senior Wealth Advisor
ScotiaMcLeod®, a division of Scotia Capital
Scotia Wealth Management