Alternative investments are those that fall outside of the traditional set of investment asset classes, which include stocks, bonds, and cash. Unlike traditional asset classes, most alternative investments, with the exception of public REITs, do not trade on public stock exchanges. This is because they lack many of the regulations found with stocks and bonds.
Exchanges provide a readily deep pool of buyers and sellers, which make liquidity available. Transacting off-exchange means giving up access to that liquidity, making most alternative investments illiquid assets.
List of Alternative Investments
Alternative investments are made up of a set of investments you’ve likely already heard of. They include:
Hedge fund investments are generally reserved for high net-worth individuals or accredited investors. Funds are pooled into an investment fund and are usually focused on high-risk investment opportunities.
Real estate
Real estate is considered an alternative investment and ranges from owning rental properties to investing in real estate funds, which we will discuss in the next section.
Private equity investments are investments made into companies not listed on a publicly-traded exchange.
Commodities
Commodities are investments into raw materials or resources.
Collectibles (art, stamps, antiques, or wine)
Investments in collectibles includes tangible items like stamps, antiques, or wine.
Of those listed above, collectibles can be the most difficult for accurate price discovery. In some cases, there isn’t a readily available market, which can leave some investors with a significant loss when it's time to sell their investment.
Unlike the other investments on the list, some commodities can be traded in public exchanges. These are commodities wrapped within securities such as gold, silver, oil, agriculture products, and more. Commodities such as gold bullion (gold bars) and raw silver are still bought and sold off of exchanges.
Alternative Investments in Real Estate
As mentioned above, real estate is a form of alternative investment. This includes purchasing investment properties, like commercial buildings, residential real estate, and rental properties, among others. There are many ways to invest in real estate besides directly purchasing a property.
Real Estate Investment Trusts (REIT)
A REIT is a trust that invests in real estate that seeks to produce income and pays at least 90% of its taxable income in the form of shareholder dividends each year to its shareholders. To invest in a REIT, an investor purchases shares which are used by the trust to purchase real estate or real estate assets. To qualify as a REIT, the fund must make at least 75% of its income through real estate-related activities and have at least 75% of its total assets in real estate.
Qualified Opportunity Zones (QOZs)
Opportunity zones were established in 2017 under the Tax Cuts and Jobs Act to boost the real estate markets in certain areas of the United States. Opportunity zones are qualified using census data and through referrals from state governors and approval from the U.S. Department of the Treasury. There are currently over 8,700 QOZs in the United States. They are usually low-income areas.
Investors can purchase real estate in these designated zones through QOFs. Investments can be for many types of real estate including commercial, multi-family, or single-family housing, under certain conditions.
Delaware Statutory Trusts (DST)
A DST is a pre-packaged investment on a property put together by a sponsor. After the sponsor does due diligence, negotiates lease terms, and takes other steps to put the package together, then they offer equity to investors. The trustees pool their 1031 exchange funds for the investment and then receive cash distributions if the property is profitable.
Some Alternative Investments Are Illiquid
Many alternative investments lack liquidity because there isn’t a public exchange to transact (i.e., buy/sell). Buyers and sellers often meet through word of mouth, or they may even see an ad by a firm pitching an alternative investment. These deals take longer and have a higher transaction cost than publicly traded securities. Such is the nature of private deals.
When investing in alternative investments, be prepared for a more involved transaction with higher fees and longer holding times than publicly traded securities.
It’s also important to work with someone experienced in the specific type of investment you’re considering. You want the best price discovery possible. Because the investment is private, pricing information can be difficult to come by. That doesn’t mean it isn’t available and that a good deal can’t be made.
Who Should Consider Alternative Investments?
Some alternative investments, such as private equity and hedge fund investments, are restricted to accredited investors. This is because these alternative investments can be complex and should only be sold to experienced investors that are able to sustain a large loss.
Institutional investors, such as endowments and pension funds, are also involved in alternative investments.
The reason individuals and institutions get involved with alternative investments is for their potential to produce attractive, risk-adjusted returns. Because these are more sophisticated investors, they can handle locking up some of their capital for several years without it affecting them much.
Alternative investments within the same asset class may be set up differently. This is why working with a financial professional who can guide you along in the process of purchasing alternative investments should be part of your plan.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
