Alternative Investments in a Nutshell
Hedge funds, Real Estate, Loans, Structured products, VCs, and much more
When it comes to alternative investments, it is important to know how to invest your money smartly and efficiently, while considering all relevant risks – just as you would with any other investment type.
What are alternative investments?
Alternative investments are investments that extend beyond the scope of the traditional stock market, namely investments in securities that are not open to public trade (as opposed to the stocks and bonds). Classic characteristics of these investments include reduced availability, lower liquidity, an illiquid (or nonexistent) secondary market (or exchange), and far less significant regulation.
Why should you invest in alternative investments?
Alternative investments expose investors to many fields they otherwise would not be exposed to when engaging in “traditional” investments on the stock market, via stocks or bonds. One such example is the hi-tech industry. For the average investor, it can be extremely challenging to venture into the startup world via the stock market – a huge loss for those living in the “Startup Nation.” This is also true for infrastructure and foreign real estate. These investments can lead to additional returns and exposure to products and assets that are not available via the traditional stock market.
Main types of alternative investments (partial list)
Real estate funds
- These investments are usually made via partnerships in the real estate field and not by trading stocks or via a REIT fund.
- Direct investment in an asset is generally reserved for high net-worth investors. It also requires broad knowledge and resources to determine suitability and perform deep and other analyses. Conversely, investing via a non-tradeable fund enables investments to be made at a lower entry level, where suitability tests are usually performed by experts who also consult clients on making smart investments. Such a form of investment enables greater diversification than would otherwise be secured by directly investing in an asset.
- Real estate is a significant element in an investment portfolio, capable of offering stable flows and returns against inflation, and diversification with respect to other investment options within a portfolio.
- Efficient real estate portfolios must include a variety of locations, sectors, and strategies.
- The main drawback of this type of investment is the loss of liquidity, as the investments are made for the long-term, up to 10 years or even longer. Investors seeking to invest in this sort of funds must understand that their money will not be available for a long time.
- Like real estate funds, here there is also a possibility to gain exposure to profitable non-tradeable assets with continuous income from these funds. For the most part, these investments are made via limited partnerships.
- The infrastructure assets included in this investment type are, but are not limited to: toll roads, water desalination plants, and power stations.
- Interest rates in Israel and abroad significantly impact the valuation of the non-tradeable assets. As most of the projects are for the very long-term, even a relatively small change in the interest rate can significantly influence the assets’ valuation – for better or worse.
- Here too, the main drawback is the lengthy duration of the investment and the lack of liquidity – for 8-10 years or even longer.
Real estate credit funds
- These funds provide mostly short-term loans in the field of real estate, such as bridge loans, mortgages, and mezzanine financing.
- These funds enable borrowers to enjoy a broader spread and a more diversified portfolio.
- In some cases, these loans are provided against senior debt or personal collateral.
- Fund managers perform comprehensive suitability tests on the assets and initiatives for which the funds are to extend lines of credit.
- It is important to ensure that the fund manager hinges extending a line of credit from the fund upon the investment of personal capital by the deal’s initiator.
Social or peer-to-peer lending
- The past decade has seen significant technological development, as well as the establishment of internet lending platforms that place the lender on one side – a private individual, institutional investor, bank, etc. – and the borrower on the other.
- These investments are based on smart credit platforms that enable the provision of direct (consumer or business (credit, without the mediation of banks or credit card companies. Israel is home to several of these types of companies and they successfully raise significant capital.
- This technological model is interesting in and of itself and should be implemented on a large scale. The promise for more dispersed credit risk is theoretically correct and can be executed by extending loans to hundreds, if not thousands of borrowers. The reasoning behind the concept is that there is no correlation between the loans and the borrowers’ ability to repay them. As such, any related risk should be low. That being said, history has taught us that the correlation between different people can increase during times of economic recession (such as during the 2008 financial crisis).
- Private investment funds, generally bundled as partnerships, where the managing partner has the sole right to do as they wish with the fund’s funds, in line with its investment strategy.
- Some hedge funds are extremely leveraged (by extending large loans), and with broad financial derivatives (options and futures).
- The fund manager’s fees tend to be high (usually a 2% annual management fee and 20% of the earned profit, or over a certain threshold).
- Hedge funds are subject to less regulatory supervision than other managed portfolios or classic trust funds.
- It is important to note that there are many types of hedge funds that have most of their money invested in classic tradeable assets on the stock market, such as stocks and bonds.
- A structured product or note is a debt security issued by a bank. Its performance is a derivative of an underlying asset’s performance (stock, index, currency, commodity) or those of several underlying assets.
- By debt security, we mean that the issuing bank commits to payment conditions that reflect the product’s prospectus in advance. This commitment is valid so long as the issuer does not become insolvent. As such, the quality of the issuing bank and its financial strength are critical to an investment in a structured note
- The main advantage of structured products is that they provide a relatively high degree of certainty with respect to the returns and risks, as the terms of the investment are well defined prior to making the investment
- Another advantage is the ability to clearly and precisely customize the risk/return profile and adapt it to the investor’s needs. This means that structured products could potentially provide a more compelling risk/return profile relative to traditional bond and equity investments, especially during periods of high uncertainty and low returns.
- Structured products can be classified into three main groups:
- Capital Protected Products (Structured Deposits): The initial investment is protected at the product’s maturity and returns depend on the underlying asset’s performance.
- Coupon products with a conditional capital protection: The initial investment is protected, so long as the underlying asset does not drop below a certain lower threshold. The coupon could be guaranteed (paid independent of the underlying asset’s performance) or conditional, upon the underlying asset’s performance.
- Participation products: Products for which upside is proportional to the positive performance of the underlying asset. As opposed to coupon products for which the coupon is known ahead of time, here the potential return is not known in advance. Typically, these types of products come with a conditional capital protection and tend to serve as an alternative to direct investments in the underlying asset
- Other types of structured products exist, as well as products that are a combination of both basic types.
Venture Capital funds
- Venture capital funds are investment centers that, for the most part, search for early-stage companies in innovative fields, such as technology and medicine (biotech). They survey and invest in hundreds of promising startups to identify the next Google, Apple, or Amazon.
- It goes without saying that a large portion of the invested funds amount to nothing; only a few of the startups actually succeed. Even then, their success tends to be moderate at best.
- The process of investing in these funds is like that of investing in hedge funds and generally involves relatively high management fees.
Advantages and disadvantages
Most alternative investments are illiquid. Money is invested in them for long periods of time and when they can be made liquid – it can take a while for the money to reach your hands. In addition, minimum required investment sums are relatively high, and the level of investor transparency is low.
Alongside these blatant and well-known disadvantages, it is important to remember that these investments enable risk diversification, which, in turn, enables the generation of preferential yields, especially during such a challenging period where interest rates are negligible.
Note that there are no “free meals.” No returns come without risk. This is the case with these investments. Attractive, potential target returns include significant risk for losing the investment fund, or at least a significant part of it.
How to choose an alternative investment
The path towards choosing a suitable investment – one that is reliable, high-quality, profitable, and meets the investor’s unique needs – involves meeting with a responsible and impartial investment expert. This is where we, at Pioneer Wealth Management, step in. We are always on our clients’ side, helping them find the right products for their investment portfolios.
These decisions, made solely according to our clients’ needs and without any external considerations, are made possible thanks to our business model. We do not receive commissions for your investment decisions, as is accepted practice in the industry. We only decide to invest in each alternative investment product after researching and engaging in a professional analysis of the investment. Pioneer implements the research and analysis on behalf of our clients, as part of our comprehensive service package, to offer the best possible products available in today’s market.
We examine each product in depth and determine the quality of the debt, how the investment returns to the client, the product manager’s history, what guarantees exist in case of insolvency or a financial crisis, etc. We also perform analyses pertaining to target data, such as expected target yield, project worth, stress tests, and more.
The significant growth of the alternative investment field has brought with it a wide variety of possibilities. It is important to remember that this attractive channel is generally best suited to investors with significant capital available for long-term investment, as well as with lots of patience with respect to when it will be accessible. In addition, this channel requires additional caution and attention to the small print, so that each investment made is calculated and responsible.
The aforementioned information is not a substitute for personal investment marketing or portfolio management, which takes into account the particular circumstances and special needs of each person.