Alternative investments

Definition

Alternative investments refer to asset classes that differ from traditional investments like stocks, bonds, and cash. These investments can include real estate, hedge funds, private equity, commodities, and collectibles, and they are often sought for their potential to enhance portfolio diversification and improve overall returns.

5 Must Know Facts For Your Next Test

1. Alternative investments can provide higher potential returns compared to traditional assets, but they often come with higher risks and lower liquidity.
2. These investments are typically less correlated with traditional market movements, making them attractive for diversification purposes.
3. The due diligence process for alternative investments is more complex and may require specialized knowledge to assess their value and risk.
4. Many alternative investments have high minimum investment requirements, making them accessible primarily to institutional investors and high-net-worth individuals.
5. Regulatory frameworks around alternative investments can vary significantly by region, impacting how these assets are marketed and sold.

Review Questions

• How do alternative investments contribute to portfolio diversification?
  • Alternative investments can provide diversification benefits because they often have a low correlation with traditional asset classes like stocks and bonds. By including assets such as real estate or commodities in a portfolio, investors can reduce overall risk since these assets may perform differently under various economic conditions. This means that when traditional markets are down, alternative investments might hold their value or even appreciate, helping to stabilize the overall portfolio.
• Discuss the risks associated with investing in alternative investments compared to traditional asset classes.
  • Investing in alternative investments carries distinct risks such as lower liquidity, higher fees, and a lack of transparency compared to traditional assets. Many alternative investments are not easily traded on public exchanges and may require longer holding periods. Additionally, the complexity of these investments can make it harder for investors to assess their true value or associated risks, potentially leading to significant losses if not managed properly.
• Evaluate the role of regulatory frameworks in shaping the landscape of alternative investments and their accessibility to different types of investors.
  • Regulatory frameworks play a crucial role in determining how alternative investments are offered and who can access them. These regulations often set minimum investment thresholds that can restrict participation to accredited investors or institutional clients. This creates a barrier for average retail investors who may miss out on potentially lucrative opportunities. Furthermore, regulatory oversight can impact the types of strategies that hedge funds or private equity firms can employ, influencing the risk-return profile of these investments in the market.

Related terms

Hedge Funds: Investment funds that employ various strategies to maximize returns, often using leverage and derivatives, which are typically open to accredited investors.

Private Equity: Investments made in private companies or buyouts of public companies that result in the delisting of public equity, often involving a hands-on approach to management.

Real Estate Investment Trusts (REITs): Companies that own, operate, or finance income-generating real estate, allowing investors to earn a share of the income produced without having to buy property.