In the world of investing, alternative assets or alternatives are your non-traditional asset classes (stocks, bonds and cash). So quite an open definition and a lot of scope for what is an alternative asset, and for the purposes of this discussion we’ll include property as a traditional asset class.
Why do people invest in alternatives? Think about the old adage of not putting all of your eggs in one basket. The main reasons to invest in alternatives is to diversify your portfolio – a risk management technique that mixes a wide variety of investments. By not having all of eggs in one or two baskets you actually reduce the risk and correlation of your investments. This means when there’s a crash in one stock or the entire market the loss is likely to be lessened by the other assets in your portfolio.
There are many different types of alternative assets that people can and should invest in. Some of the more traditional alternatives are gold, hedge funds, venture capital investments and infrastructure assets. Some of the less “investable” but more common alternative investments people hold quite often are not for investment reasons. These are art, antiques, coins, stamps and other collectibles, even fine wine. So you might already have some and not realise it. Keep in mind that the 10yr old case of Oyster Bay Merlot probably doesn’t quite cut it and is probably over the hill!
The problem with this is these tend to be the domain of the wealthy and are difficult investments to make and hold so you need to be careful in investing in them. A recent example is the record sale of a Paul Gaugin painting that sold for US$300m or the 1962 Ferrari 250 GTO that sold last year for US$38m. While these are the extremes they are reflective of the staggering cost and investment required when investing in collectables.
The new world of alternative assets includes alternative finance such as peer-to-peer (P2P) and equity crowdfunding. Two simple concepts that utilise the reach and efficiency of the internet to allow many investors to contribute a small amount to fund a loan or to buy shares in business. People are investing in P2P loans and Equity Crowdfunding not purely for the returns but the passion and motivation from helping fund people in their local community or with great ideas and businesses they really believe in. It’s a chance to bring passion back to investing!
What are some of the issues in investing in Alternatives? The greatest problem with alternative assets is their liquidity, most are extremely illiquid meaning you cannot sell them quickly and easily if you need to convert them to cash. Another issue relating to this is they can be very difficult to value, so it can be hard to know the value of your portfolio. For this reason it is smart to have alternatives as a fraction of your portfolio.
How much should I invest in Alternatives? This is the difficult part, some US brokers like Merrill Lynch and Morgan Stanley suggest that you can have up to 30-40% of your portfolio in alternatives. However, this is not practical or appropriate for retail investors and the general assertion is that retail investors should have anywhere from 5-15% of their portfolio invest in these assets and importantly not all in gold or art or venture capital, you should have a mix.