After posting my last article on financial literacy (link), I received a lot of feedback and queries from the people that they are somewhat aware of traditional investment avenues and they were curious whether any other investment avenues are available which are not known to many but might generate better returns than traditional investments. There are investments called as alternative investments in which risk-loving investors can invest.
What is an alternative investment?
These are non-traditional investment things which do not invest in traditional investment assets like equities, bonds, cash and bank deposits. Investments in alternative investments include private equity, private debt, hedge funds, vintages and collectibles like wine, art, paintings or cars. There’s still ambiguity whether to consider real estate as an alternative investment or not.
Disadvantages of alternative investments:
- Low Liquidity: It’s easy to redeem a bank FD, buy or sell a stock or to purchase a bond. But it is comparatively difficult to buy or sell vintage wine or paintings of famous artists. Low liquidity is one of the reasons of better returns on alternative investments.
- Absence of benchmarks: Returns on traditional investments can be easily compared with relative benchmarks (e.g. return on SBI stock can be benchmarked against return of NIFTY or SENSEX) but due to absence of relative benchmarks in alternative investments, returns cannot be benchmarked.
- Difficulty in valuation: All traded investments and deposits can be valued easily by obtaining its last market traded price. But as alternative investments are not traded often, it becomes very difficult to determine the exact value of the investment.
- Other costs: Due to high ticket purchases, alternative investments have higher administrative, legal and storage expenses. (e.g. cost of storing a bank deposit receipt is low but cost of saving precious coins or a vintage car is much higher).
- History of scams: The main motto of alternative investments is to generate maximum returns in the minimum holding period. This has led to many serious frauds and Ponzi schemes.
- Volatility: Due to random and non-predictive nature of investments, investors can suffer huge losses due to market fluctuations. (Remember: great rewards come with great risks)
Advantages of alternative investments:
- Diversification: Investing in non-traditional assets provide better and wide diversification.
- Possibility of better returns: Due to random, volatile and risky nature; alternative investments tend to generate better returns compared to traditional investments.
- Insulation from volatile equity markets: Alternative investments provide insulation from the daily volatility of equity markets.
Investments in higher return-generating assets can be tempting but they also carry high risk. An investor should be diligent, do a detailed study and risk analysis before investing in alternative investments. A successful investment needs discipline and patience.
Chinmay Madgulkar is an Electronics & Telecommunication engineer from the University of Pune. He has completed his MBA in Finance from Xavier Institute of Management & Research and is a Management Trainee - Equity at Taurus Mutual Fund. He is also a Mutual Fund advisor.
You can connect with Chinmay on LinkedIn here.