Alternative investments can be a valuable investment tool, but they are also a diverse group which is not appropriate for every investor. We explore some of the key alternatives in more detail and look at the benefits and risks of investing in them.
What are alternative investments?
Alternative investments are defined as asset classes outside of traditional assets. The asset classes of equities, bonds and cash are often referred to as traditional assets, with everything else falling into the category of alternatives.
However, the term could also be used to describe conventional assets which have more complex strategies applied to them.
For example, ‘long/short’ strategies that involve taking offsetting ‘long’ positions (investing in asset price appreciation) and ‘short’ positions (betting on price falls) are usually thought of as alternative investments, even when applied to a traditional asset such as equities.
Investment in alternatives can be direct but, due to their characteristics – which can include low liquidity, high transaction costs, large minimum investment amounts and complex strategies – many investors access alternatives through funds in order to pool resources with other investors.
Types of alternative investments
Some alternatives can be grouped together into sub-categories such as real assets, including real estate, commodities and infrastructure. Overall, however, alternative assets are a large and diverse group.
These are some of the key alternative investment types:
Residential and commercial real estate (including industrial, office and retail) both offer investment opportunities. As well as the potential for price appreciation, real estate typically also offers good income streams due to rental payments. Investment can be direct but due to the large sums and high transaction costs involved, most investors typically access property investments through funds – managed by professional investors – which pool investors’ resources together to achieve a scale that allows diversified, cost-effective investment. As with other types of real asset, real estate is thought to offer good protection against inflation.
Commodities/natural resources
This includes physical ‘hard’ commodities such as oil, precious and base metals or ‘soft’ agricultural commodities such as grains, coffee and cocoa. Investment in commodities can involve direct ownership and storage of physical commodities or the use of financial instruments known as derivatives that track commodity prices. It is also possible to invest in the natural resources directly via, for example, agricultural land which produces soft commodities or timber.
Infrastructure
Usually involves ownership and operation of long-lived public assets such as toll roads, bridges, ports and airports. Infrastructure can also include social assets such as schools and healthcare facilities. Typically, these projects include a large initial capital outlay in the construction phase, followed by a long payback period in which the asset generates steady cash flows – for example, from toll fees on a road or bridge.
Hedge funds
These funds typically operate more complex strategies than funds that invest in traditional assets in the hope of price appreciation (sometimes referred to as a ‘long only’ approach). For example, hedge funds may deploy long/short strategies and borrow money in order to leverage returns. Because of the complexity of the investment strategies, investors appoint a professional fund manager to make investment decisions.
Hedge funds often target positive absolute investment returns in all market conditions rather than seeking to outperform a market benchmark in relative terms. They also often levy a performance fee payable to the investment manager in addition to the standard annual management charge.
Private equity
Equity investment in privately-owned companies, i.e. those that are not listed on public stock markets, or in public companies with a view to taking them private by de-listing them from a stock exchange. Private equity investors typically borrow large sums in order to allow them to buy companies, which is called a leverage buyout (LBO). When the management of a company invests alongside private equity investors in order to buy out all the other investors in a publicly listed company, the deal is referred to as a management buyout (MBO).
Private equity investors seek to increase the value of a company by restructuring its operations, often focusing on cost control and cash flow maximisation. Some of the tools they use to achieve this are thought to be easier to deploy in privately held companies, away from the publicity of a stockmarket listing.
Private debt
In contrast to investing in publicly-issued bonds, which are securities that are traded by recognised market makers and assigned credit ratings by agencies, private debt involves direct lending to companies. Private debt may provide the potential for higher returns to professional investors with the resource to conduct their own analysis of investment opportunities, but the risks are also likely to be commensurately higher.
Collectibles
This group includes fine wine, coins, stamps, art and antiques. These physical assets require storage, which can be expensive. While they can be illiquid and generate unpredictable returns, collectibles typically display low correlation with other assets, a valuable characteristic for some investors.
Advantages of alternative investments
Alternatives offer diversification by offering an investor a larger universe of investments, as well as different risk and return characteristics compared with traditional asset classes.
Their limited correlation with traditional assets means that they can potentially improve portfolio diversification, enhancing returns or reducing volatility when held alongside other assets.
However, alternative investment markets are potentially less efficiently priced than traditional assets due in part to their illiquidity and typically lower levels of publicly available information. This can offer the potential for higher returns for investors with the risk tolerance and time horizon to allow for long-term investments.
Many alternatives also offer the opportunity to hedge against inflation and to generate a good income stream.
Risks of alternative investments
Some alternative investments have less regulation than traditional investments and are also likely to suffer from a relative lack of historical returns data or other information which is important for investment analysis.
Alternatives can be illiquid and sometimes investors are subject to a lockup period during which they cannot access their investments. Alternative investments can also involve sophisticated investment strategies and leveraged returns due to borrowing.
For these reasons, alternative investments can be higher risk than traditional investments.
Due to the need for professional investment management expertise, and the high transaction costs involved in some alternatives, investor fees can be higher than for traditional investments.
KEY RISKS
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
DISCLAIMER
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell investments mentioned, or a solicitation to purchase securities in any company or investment product.
The information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, whether express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.
Before making an investment decision, you should familiarise yourself with the different types of specific risks associated with the investment portfolio of each of our Funds and Multi-Asset Model Portfolios. For Liontrust Funds, this information can be found in the final Prospectus and Key Investor Information Documents (KIIDs) and/or PRIIP/KID available on our website: www.liontrust.co.uk. Our Multi-Asset Model Portfolios are available exclusively through financial advisers. Financial advisers can find further information on the different types of specific risk associated with the Liontrust Multi-Asset Model Portfolios in the relevant brochure, also available on our website: www.liontrust.co.uk. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
