5 Types of Alternative Investments

As an investor, you likely have experience with traditional investments like stocks, bonds, and cash. However, record-high inflation in the U.S. has made such assets more vulnerable to market turbulence. Fortunately, other categories of alternative investments exist to offer investors like you more flexibility to help meet your risk appetite and investment goals.

Alternative assets are generally characterized by their lower correlation to markets and tend to be fairly illiquid but may have the potential for higher returns compared to the general market.^* Here are five different types of alternative investments — private equity, private debt, hedge funds, commodities and structured products. Let's explore how these alternative investment examples may help you diversify your portfolio and help you manage risks during times of uncertainty.

1. Private Equity

Private equity is a common investment alternative. This capital investment strategy involves partnerships that buy a stake in private companies not listed on public stock exchanges. Private equity firms buy these companies, aiming to earn a profit when it's sold once again. Investors in this asset class generally must commit significant capital for long periods of time, and this option tends to be popular when interest rates are low and stock prices are high.

Private equity companies typically provide more than just capital to the firms they purchase, such as offering mentorship, industry expertise and talent-sourcing assistance benefits to their founders. There are several subsets of private equity, including:

Venture capital: Investing in venture capital enables investors to fund young businesses, such as startups, that show potential for long-term scaling and growth. This private equity strategy offers investors a stake in company ownership and potentially above-average returns.
Growth capital: This private equity investment method helps more mature companies develop, expand or restructure. Investors can acquire more decision-making power and stake in the business than venture capitalists.
Buyout: This strategy occurs when payment is made to purchase a company or one of its divisions to gain a controlling interest in the company. A buyout typically takes place when an acquiring party believes there is opportunity to make a positive return on their investment.

2. Private Debt

Private debt covers different investment styles and strategies, however, typically involves debt instruments that are not financed through bank loans or traded on an open market. Instead, private debt funds are used as a strategy when companies need additional capital to scale their business, in which they receive money through repayments on the initial loan and interest payments.

Both public and private companies can borrow using private debt, which provides more flexibility to diversify away from listed bonds and growth assets for financing. With private debt strategies, investors may have access to lower volatility and potential income-based returns.^* These loans generally receive a floating rate, which is appealing to some investors who want to help soften the impact of inflation on their returns.

Here are some ways one may invest in private debt:

Direct lending: As one of the broadest avenues of private debt, direct lending involves providing loans to companies of all sizes, from small startups, or large-cap companies.
Mezzanine lending: Using a combination of debt and equity financing, mezzanine lending can be used by investors to raise funds for projects and convert the debt to an equity interest in the business in case of default.
Distressed debt: Investors can purchase debt securities at a discount from companies undergoing financial stress, potentially gaining a profit once the business restructures or goes through bankruptcy.

3. Hedge Funds

Hedge funds, which are usually only available to accredited and high-net-worth investors, are investment pools with the goal of earning higher returns on investments. These investments include things like pension funds, stocks and mutual funds, for example.

Professional fund managers oversee these limited partnerships between private investors using various strategies to help achieve this goal, including trading of non-traditional assets, volatility arbitrage and long-short equity. Because of the potential risks involved, this alternative investment choice generally requires a high minimum investment and a sophisticated understanding of applicable risks.

Here are some common strategies that seek to maximize return potentials within a hedge fund:

Global macro: These actively managed funds are developed according to the socio-political and economic state of a country and its policies. These funds enable investors to freely invest in any security and potentially profit from broad market swings.
Relative value: Hedge funds often use this approach to investing to take advantage of temporary differences in the prices of related securities.
Managed futures: Professional fund managers can employ this strategy of managing futures contracts to help manage portfolio risk while seeking to gain profits.

4. Commodities

Commodities are alternative assets usually refers to raw material used to manufacture finished goods such as natural resources, precious metals, natural gas, oil and agricultural products. Commodities are unaffected by market fluctuation, so they may help provide a hedge against inflation. Because these tangible goods have real world uses, they usually maintain perpetual demand due to the fact that they have a wide range of uses in many different industries.

Some investors decide to pursue this type of alternative asset management because they offer portfolio diversification. Investors can trade commodities in the cash market or through options and futures. Investors can also use this type of alternative investment to participate in commodity trading platforms, mutual funds, or exchange-traded funds.

Additionally, investing in a commodity fund means investors may benefit from higher liquidity and can sell them at any time. However investors typically don't receive dividends from commodities because they don't generate revenue.

5. Structured Products

Structured products are pre-packaged investment alternatives that usually involve fixed-income markets. This type of investment includes assets linked to interest as well as one or more derivatives, which are often tied to a basket of securities. Structured products are designed to facilitate risk-return objectives that are highly customized by using traditional, investment-grade bonds and replacing conventional payment features with non-conventional payoffs.

Instead of coming from the issuer's cash flow, these payoffs are derived from the performance of underlying assets. Examples of structured products include collateralized debt obligations (CDO) and credit default swaps (CDS). Investors may invest in a customized mix of structured products as an ideal way to help meet their individual needs and provide easier access to derivatives.

This type of investment can also be principal- guaranteed that issues returns on the maturity date. However, keep in mind that this alternative investment strategy comes with risks as it’s relatively complex and may not be insured by the Federal Deposit Insurance Corporation (FDIC).

Learn About Alternative Investments

Navigating investments can seem like a daunting task, especially during times like these. Alternative investment strategies may be a suitable option to help make your portfolio more diversified. At Bangerter Financial, we're committed to helping investors and high-net-worth individuals understand all the risk factors and potential benefits of alternative investments before making a decision.

For over 40 years, our experienced advisors have helped our clients achieve their goals and find the right alternative tax strategies for their unique situation. To learn more about our services, call us today at 916-866-3439 or complete our contact form online.

* Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor.

This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Hedge Funds are unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including mutual fund requirements to provide certain periodic and standardized pricing and valuation information to investors. Hedge Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments are often sold by prospectus that discloses all risks, fees, and expenses. They are not tax efficient, and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain and should not be deemed a complete investment program. The value of the investment may fall as well as rise and investors may get back less than they invested.

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC-registered investment advisor. Insurance offered through Concorde Insurance Agency, Inc. (CIA). Bangerter Financial is independent of CIS, CAM and CIA.

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