What are alternative investments and how do they integrate in your investment portfolio?

What are alternative investments?

The alternative investments market began growing significantly in recent decades, especially due to the economic crises in traditional markets. Alternative investments offer a unique approach to wealth management that differs from the familiar channels, such as stocks, bonds and cash. Unlike traditional investments, these channels are not directly dependent upon the volatility in the capital market and may enable relatively high stability and risk diversification in investment portfolios. In an era when inflation and economic changes such as money printing can erode the value of money, alternative investments may constitute an effective solution for preserving capital and adapting portfolios to the changing financial reality. Today, the accessibility of financial information enables investors to make informed decisions and weigh the advantages of these channels as part of their strategy for achieving long-term stability and growth.

Examples of alternative investments:

• Real estate: purchasing various types of properties that enable leverage constitutes a relatively solid and less volatile investment. Investing in real estate offers two main categories of potential profits: capital gains (profit from real estate appreciation) and cash inflows (from current income and rents). It also includes opportunities to invest in different types of properties, such as logistic, commercial, residential and hotel properties. Real estate investments usually generate cash flows and can contend with impacts of inflation.
• Private equity (PE) funds: PE fund structures enable wider diversification and a wider range of segments, which may protect investors’ money and mitigate risks. For example: investing in high-tech companies, real estate or infrastructure or investing in private companies and improving them in order to increase their value.
• Hedge funds: hedge funds employ sophisticated actively managed strategies for investing in a variety of assets, as well as techniques such as short selling and leverage. Their main objective is to generate returns even during periods of declines in the traditional stock market.
• Venture capital (VC): investing in innovative early-stage startups with high growth potential, such as in the fields of technology, digital healthcare, renewable energy, etc.
• Commodities: investing in physical assets, such as gold, silver, oil and agricultural goods, with the objectives being to hedge against inflation and contribute to diversification of investment portfolios.
• Specialized assets: investing in digital currencies, works of art and unique collectibles. This channel may offer potential for generating unique value that is independent of traditional capital markets.
• Private debt: investing in private loans to companies or projects not traded on stock exchanges. This channel is used to generate regular cash inflows that may be higher than the alternative of bank deposits. A non-leveraged loan with collateral is a loan posing very limited risk.

Why is it worthwhile to consider alternative investments?

Alternative investments offer unique advantages for investors looking to expand their investment portfolios and improve their resilience:

• Low correlation with the capital market: Past performance shows that these assets behave relatively independently of traditional markets, which may reduce volatility in the portfolio and provide stability over time.
• Access to nontradable assets: Alternative investments allow access to assets that are not available to the general public.
• Wide variety of investment options: Investing in real estate, private equity funds or debt funds, for example, enables wider diversification and reduces dependence on a particular market or sector.
• Diversification among different sectors: Investors may diversify their investments in sectors such as residential real estate, commerce, infrastructure and other sectors, which may reduce the risk of exposure to a specific sector.
• Option to engage in focused investments in specific assets: If an investor’s strategy is to focus investments in a specific field, he/she may invest in individual assets, such as in a specific real estate project or private company.
• Possible protection against inflation: In real estate, for example, rent payments are usually linked to the CPA, which enables protection against price increases.

What is important to know before you start?

• Liquidity: Alternative investments are not always liquid, which means that you cannot suddenly decide to realize your investment. Alternative assets are largely held by groups of investors cooperating in long-term business plans, such as real estate partnerships, real estate funds or private equity funds. This means that access to money depends upon the type of investment and its proposed structure (e.g., open/closed fund). Therefore, alternative investments are suitable mainly for investors who engage in long-range planning and manage a portion of their capital separately from liquid investments.
• Information and transparency: Alternative investments require comprehensive due diligence examinations, including risk assessments, a review of the managing entity and analyses of the investment terms. Choosing  experienced, professional management entities with proven track records is critical to success. It is also important to scrutinize the tax and regulatory aspects, especially prior to engaging in global investments, in order to avoid surprises or unexpected costs.
• Customization: Alternative investments should be tailored to each investor’s individual needs, objectives and financial ability. Sometimes, alternative investments are only open to qualified investors. Inter alia, investors should take into account the duration of the investment, the ratio between short-, medium- and long-term assets and the desired level of leverage. Adapting the investment to your personal investment strategy ensures that the investment will optimally integrate into your portfolio. 

Main considerations when selecting an alternative investment 

Selecting an alternative investment requires a strategic approach and careful planning that takes a variety of factors into account and ensures an optimal solution for your needs and objectives:

• Defining your investment objectives: First you must decide what you are seeking: is it stable cash inflows, risk diversification or potential capital gains? Each of these objectives has appropriate channels, and it is important to focus on your main objectives.
• Compatibility with the existing portfolio: Alternative investments serve to support your financial strategy, whether by adding stability or by increasing the risk diversification. It is important to examine how compatible the selected channel is with the other assets in your portfolio and what its overall contribution will be.
• Choosing a professional management entity: The success of an investment depends considerably on the entity that is managing it. Choose entities with a proven track record of experience and transparency that will provide comprehensive information and manage the asset professionally.
• Duration and liquidity of the investment: Alternative investments often require medium- or long-term commitments. Therefore, make sure that the money that you invest is not needed for immediate needs. Planning ahead will help prevent financial stress in the future.
• Weighing risks and returns: Since every investment poses some degree of risk, it is essential to understand the overall level of risk and weigh it against the potential return. You should thoroughly scrutinize the characteristics of the investment and assess whether it is within the bounds of your risk appetite.