8 ALTERNATIVE INVESTMENTS EVERY INVESTOR SHOULD KNOW!
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Welcome to another insightful blog post from ARTIFICALAB LTD, where we will share about the world of finance and investment. Indeed, this post is part of our knowledge series, designed to complement our Financial Analysis & Investment Courses available on Udemy. Today, we explore the top 10 alternative investments every savvy investor should be aware of. Let’s get started!
Before we dive into it, have you heard about what kinds of investments are considered as Alternative Investments? If not, let us show you in the below section! Follow with us!
What are Alternative Investments, and Why Are They Called Alternative?
Alternative investments
Alternative investments are actually considered as financial assets that do not fall into the conventional categories of stocks, bonds, or cash. In fact, these investments include a wide range of assets such as real estate, private equity, hedge funds, commodities, and collectibles.
So much speaking, we can all alternative investments where they could exhibit their own risk and reward profiles, while a completely different forms of investments than stocks, bonds and cash.
In traditional investments, we normally conceive them as safer assets compared with alternatives. One of the examples is the Fixed Income securities such as Bonds.
However, in this blog post, we will talk about a little more adventurous investment assets, which are called "Alternative Investments".
Then, Why Are They Called Alternative?
One of the things Alternative Investments are different from Traditional ones is that they provide the follow advantages to investors:
- Diversification: Investors can be rewarded with diversification benefits as they often have low correlation with traditional asset classes.
- Risk and Return: Higher returns are possible often, but actually, that also come with higher risks and less liquidity.
- Access and Regulation: For some alternative investments, they are considered typically less accessible to the average investor and are also subject to different regulatory requirements.
However, after the 2006 Financial Crisis, in which it is also known as the Global Financial Crisis (GFC), it had a profound impact on the investment landscape.
Investors no longer rely on traditional investments anymore, while looking for more weighted allocations on alternatives in their portfolios. This is because of their diversification benefits, the possibility of higher returns, as well as inflation hedge capabilities, new investment opportunities, and huge capital gains and wealth growth over long-term investment horizon.
What are the Top 10 Alternative Investments?
It is undeniable that Alternative Investments are becoming a popular choice in allocations of Investment Portfolios.
Even now, Big Firms such as Harvard University Endowment, Yale University Endowment, Ontario Teacher's Pension Plan (OTPP), and Kohlberg Kravis Roberts & Co. (KKR) etc. are now allocating over up to 60% of alternative investments in their investment portfolios!
For now, let's explore the following 10 Alternative Investments:
1. Real Estate as an Alternative Investment
The first investment, that is considered as Alternative is the Real Estate and it is my favorite investment because of its inflation-hedging abilities.
In fact, investing in real estate includes residential, commercial, and industrial properties. Investors can earn through rental income, property appreciation, or both.
However, we need to understand that there are two primary ways to invest in real estate: direct investing and indirect investing. Details of these types can be explored in our another blog post.
Examples:
Regarding direct investing, consider the Empire State Building in New York City. It is a primary example of a successful real estate investment. Purchased for $51 million in 1951, it has since appreciated significantly in value and generates substantial rental income.
Others include condominiums, townhouses, and single houses, in which all can be financed with mortgage from Banks.
However, regarding on indirect investing, the Vanguard Real Estate ETF (VNQ) is a well-known REIT that offers exposure to a diversified portfolio of real estate assets.
From a small amount of capital, investors can benefit from the income generated by the underlying properties without the need to manage them directly.
Real Estate and 2006 Financial Crisis
During the 2006 Financial Crisis, real estate protected against inflation by providing tangible assets with intrinsic value that retained their worth better than many financial instruments.
Rental properties continued to generate steady income, offering a buffer against inflationary pressures.
Moreover, real estate values, despite initial declines, generally appreciated over the long term, helping to preserve and grow wealth.
If investors financed properties with the use of fixed-rate mortgages, they largely benefited since inflation reduced the real value of their debt, enhancing returns. This combination of income generation, long-term appreciation, and debt leverage made real estate a resilient investment during the crisis.
2. Private Equity as an Alternative Investment
The next one is about investing in private equity. It usually involves investing in private companies or buyouts of public companies. Substantial returns are greatly possible, but a longer investment horizon and higher capital are typically required. Thus, it will not be suited for retail investors.
Examples:
Blackstone’s Acquisition of Hilton Worldwide (Private Equity)
Background: In 2007, Blackstone Group, one of the world’s largest private equity firms, acquired Hilton Worldwide for $26 billion. This deal was one of the largest leveraged buyouts in history.
Strategy:
- Operational Improvements: Blackstone focused on improving Hilton’s operations, including enhancing its loyalty program, expanding its global footprint, and optimizing its property portfolio.
- Debt Restructuring: The firm restructured Hilton’s debt to manage financial risk and improve cash flow.
Outcome:
- IPO and Returns: In 2013, Hilton Worldwide went public, raising $2.35 billion in its IPO. By 2018, Blackstone had exited its investment, realizing a profit of approximately $14 billion, making it one of the most successful private equity deals.
For more information about Blackstone's investment in private equity of Hilton, you can explore here.
KKR’s Investment in Dollar General (Private Equity)
Background: In 2007, Kohlberg Kravis Roberts & Co. (KKR) acquired Dollar General, a discount retailer, for $7.3 billion.
Strategy:
- Management Changes: KKR brought in new management to streamline operations and improve efficiency.
- Expansion: The firm focused on expanding Dollar General’s store footprint and enhancing its product offerings.
Outcome:
- IPO and Growth: Dollar General went public in 2009, and KKR gradually sold its stake over the following years. The company’s value increased significantly, and KKR’s investment yielded substantial returns.
For more information about KKR's private equity investment in Dollar General, click here.
Carlyle Group’s Investment in Beats by Dre (Private Equity)
Background: In 2013, Carlyle Group invested $500 million in Beats by Dre, a premium headphone and audio company founded by Dr. Dre and Jimmy Iovine.
Strategy:
- Brand Expansion: Carlyle helped Beats expand its product line and enhance its brand presence globally.
- Strategic Partnerships: The firm facilitated strategic partnerships and marketing initiatives to boost sales.
Outcome:
- Acquisition by Apple: In 2014, Apple acquired Beats by Dre for $3 billion. Carlyle’s investment resulted in a significant return, highlighting the potential of private equity in high-growth consumer brands.
If you wanna explore more information about Carlyle Group's private equity investment in Beats by Dre, click here.
TPG’s Investment in Airbnb
Background: In 2010, TPG Capital invested in Airbnb, a then-nascent home-sharing platform, during its early stages of growth.
Strategy:
- Scaling Operations: TPG provided capital and strategic guidance to help Airbnb scale its operations and expand globally.
- Technology and Innovation: The firm supported Airbnb’s technological advancements and platform enhancements.
Outcome:
- IPO and Valuation: Airbnb went public in 2020 with a valuation of over $100 billion. TPG’s early investment in Airbnb resulted in substantial returns, demonstrating the potential of private equity in tech startups.
For more information about this case study, click here.
Bain Capital’s Investment in Dunkin’ Brands
Background: In 2006, Bain Capital, along with Carlyle Group and Thomas H. Lee Partners, acquired Dunkin’ Brands, the parent company of Dunkin’ Donuts and Baskin-Robbins, for $2.4 billion.
Strategy:
- Brand Revitalization: The firms focused on revitalizing the Dunkin’ Donuts brand, including menu innovation and store redesigns.
- Franchise Expansion: They expanded the franchise model, increasing the number of Dunkin’ Donuts and Baskin-Robbins locations.
Outcome:
- IPO and Growth: Dunkin’ Brands went public in 2011, and the private equity firms gradually exited their investment. The company’s value increased significantly, providing strong returns for the investors.
For more information about Dunkin' Brands investment, click here.
3. Hedge Funds as an Alternative Investment
Hedge Funds
Before we explore more about Hedge Funds as Alternative Investments, let's us understood what Hedge Funds are typically.
Basically, hedge funds are considered as investment funds that pool capital from accredited investors or institutional investors.
Unlike private equity firms, Hedge Funds' Investment Managers take a different approach. They usually use a variety of strategies to earn active returns for their investors.
Not only that, but hedge funds are also considered less regulated. The type of assets investors can invest include a wide variety such as stocks, bonds, commodities, currencies, and derivatives and so much more.
Common Strategies used by Hedge Funds
It is a good choice to understand how Hedge Funds work, what are their key characteristics, and what types of strategies they usually use. Often times, some of the methods are proprietary and private, thus investors may not clearly understand how they perform.
However, here are some of the most common strategies Hedge Funds typically use!
Long/Short Equity:
This kind of strategy involves taking long positions in undervalued stocks while taking short positions in overvalued stocks. The main objective is to profit from both rising and falling stock prices.
Market Neutral:
This strategy aims to minimize market risk by taking offsetting long and short positions in order to generate returns regardless of market direction.
Global Macro:
This strategy involves making investment decisions based on macroeconomic trends and events, such as interest rate changes, currency movements, and geopolitical events.
Event-Driven:
Event-driven strategies focus on exploiting opportunities arising from corporate events, such as mergers, acquisitions, bankruptcies, and restructurings.
Famous Hedge Fund Case Study: George Soros (the Quantum Fund)
In times of history, there is one famous hedge fund manager, that shocked the world. He is George Soros, who managed the Quantum Fund. In 1992, Soros made a legendary trade by shorting the British pound, betting that it would devalue. This trade, known as “Black Wednesday,” resulted in a profit of approximately $1 billion for the Quantum Fund and solidified Soros’s reputation as a top hedge fund manager.
4. Commodities as an Alternative Investment
Commodities
Commodities include hard commodities like Gold, Silver, Oil, as well as soft commodities like agricultural products. Investing in them needs a good timing, most of which usually provide a hedge against inflation during Economic downtimes, and diversification for your investment portfolio.
Gold, also known as the God's Money, in Commodities
Gold has been a popular commodity investment for centuries. During economic downturns, gold prices often rise, providing a safe haven for investors.
There was a time in history, where European countries fought for the quest for Gold, since it is a valuable commodity and indicator of wealth for the whole nation. During the 16th and 17th centuries, European countries were fiercely competitive in their quest for gold, driven by its immense value and the wealth it could bring. This period, often referred to as the Age of Exploration, saw nations like Spain, Portugal, England, and France embarking on extensive voyages to the New World and other distant lands in search of precious metals.
5. Cryptocurrencies as an Alternative Investment
Cryptocurrencies in Today's AI World
While Gold is considered as one of the most valuable asset in the previous 16th and 17th centuries, things have now changed. In this age of AI and Technology, Gold is not the only asset that is considered valuable as a storage of value.
Started since 2009, by Satoshi Nakamoto, the Bitcoin Founder, the age of Cryptocurrencies Evolution has been started. Famous examples include Bitcoin and Ethereum, considered as the king of assets in the Crypto World!
However, there's a catch for investors: they offer high potential returns but come with high volatility and risk.
Two types of consensus mechanisms: Proof of Work (PoW) and Proof of Stake (PoS)
Before we understand about this Digital Asset, Cryptocurrencies, you as an investor needs to understand how crypto works!
Cryptocurrencies operate on decentralized networks that rely on consensus mechanisms to validate transactions and maintain the integrity of the blockchain. Two primary types of consensus mechanisms are:
-
Proof of Work (PoW) and
-
Proof of Stake (PoS).
1. Proof of Work (PoW)
Proof of Work (PoW) is the original consensus mechanism used by many cryptocurrencies, including Bitcoin. In PoW, miners compete to solve complex mathematical puzzles to validate transactions and add them to the blockchain.
However, the problem is this process requires significant computational power and energy. The first miner to solve the puzzle gets to add the new block to the blockchain and is rewarded with newly minted cryptocurrency.
The advantages of this PoW mechanism is that it conforms high security due to the computational effort required. Also, it also has proven track record with Bitcoin’s long-term stability.
However, there are some problems with this PoW. As you understood now, the energy consumption is very high. Also, it results in slower transaction times and scalability issues.
To solve that issue, there's another type: PoS (shown below).
2. Proof of Stake (PoS)
Proof of Stake (PoS) is an alternative consensus mechanism designed to be more energy-efficient than PoW. In PoS, validators are chosen to create new blocks and validate transactions based on the number of coins they hold and are willing to “stake” as collateral. The more coins a validator stakes, the higher their chances of being selected to validate transactions and earn rewards.
Unlike PoW, PoS results in lower energy consumption compared to PoW. Also, transaction times are faster and often provide better scalability.
However, there are some drawbacks. In rare cases, there is a potential for centralization if a few validators hold a large portion of the cryptocurrency. In fact, if the network is not sufficiently decentralized, the validator networks cannot be considered secure, since one party could take over and control everything!
Why Cryptocurrencies should be included in your Portfolio Bag?
Regardless of different perspectives on Cryptocurrencies, whether good or bad, you as a investor with open-minded, should consider this asset once a time in your lifetime.
From my perspective, it is pretty sure this could be considered gambling, if conduct without due diligence. However, there are still certain reasons you should look into it:
Diversification:
Cryptocurrencies offer a new asset class that can diversify an investment portfolio. They often have low correlation with traditional assets like stocks and bonds, which can help reduce overall portfolio risk.
High Potential Returns:
Cryptocurrencies have shown the potential for significant gains. For example, Bitcoin’s price surged from a few cents in its early days to over $60,000 at its peak. While this comes with high volatility, the potential for substantial returns is attractive to many investors.
Innovation and Growth:
The cryptocurrency space is rapidly evolving, with new technologies and applications emerging regularly. Investing in cryptocurrencies can provide exposure to innovative projects and the growth of the digital economy.
Hedge Against Inflation:
Some investors view cryptocurrencies, particularly Bitcoin, as a hedge against inflation. With a fixed supply of 21 million coins, Bitcoin is often compared to digital gold.
6. Venture Capital as an Alternative Investment
Venture Capitals (VCs)
Actually, venture capitals are form of private equity financing especially to startups, early-stage, and emerging companies with high potential or high growth.
One of the key points is that investing in Venture Capital involves ONLY investing in early-stage startups with high growth potential. Thus, the drawback is that they are too risky, since almost 80%-90% of investments could fail. However, the success of 10% in Venture Capitals can cover the costs of failure and yield great returns.
Understanding the Nature of Venture Capitals (VCs)
If you are an investor coming to this blog for investment options or viewing from investor's perspective, it is wise to know the nature of VCs before deep-dive into it.
High-Risk, High-Reward:
Venture capital is inherently risky. VCs invest in companies that are often in their nascent stages, which means there’s a significant chance of failure. However, the potential rewards are substantial if the company succeeds.
Equity Stake:
In exchange for their investment, venture capitalists receive an equity stake in the company. This means they own a portion of the company and stand to gain if the company grows and becomes profitable.
Active Involvement:
Unlike other forms of investment, VCs often take an active role in the companies they invest in. This can include providing strategic advice, mentoring, and leveraging their networks to help the company grow.
Stages of Investment:
Venture capital investments typically occur in stages, from seed funding to Series A, B, C, and beyond. Each stage represents a different phase of the company’s growth and development.
Some Success Stories
Amazon:
Amazon received early VC funding, which was crucial in its transformation from an online bookstore to a global e-commerce giant. The initial investments paid off massively as Amazon grew exponentially.
Google:
Google’s early development was significantly supported by VC funding, enabling it to scale rapidly and become the dominant search engine it is today.
Some Failure Stories
Webvan:
Despite receiving substantial VC funding, Webvan, an online grocery delivery service, failed due to overexpansion and operational inefficiencies.
Theranos:
Theranos, a health technology company, raised significant VC funds but ultimately collapsed due to fraudulent practices and unproven technology.
7. Collectibles as an Alternative Investment
Collectibles (Considered as Rare Items)
In the world of alternative investments, collectibles have carved out a unique niche. From limited edition watches to rare art pieces, these items not only hold intrinsic value but also offer the potential for significant financial returns. This blog will explore the nature of collectibles as investments, focusing on limited Patek Philippe watches, Rolex, and other rare items, along with real-world cases of success and failure.
The Nature of Collectibles as Investments
Tangible Assets:
Unlike stocks or bonds, collectibles are physical items that you can see and touch. This tangibility often provides a sense of security and satisfaction to investors.
Rarity and Demand:
The value of collectibles is largely driven by their rarity and the demand among collectors. Limited editions and unique items tend to appreciate over time, especially if they are well-preserved.
Cultural and Historical Significance:
Many collectibles gain value due to their cultural or historical importance. Items associated with significant events or famous personalities often fetch higher prices.
Diversification:
Collectibles offer a way to diversify an investment portfolio. They are not directly correlated with traditional financial markets, which can provide a hedge against economic downturns.
Success Stories of Some Famous Collectibles
Patek Philippe Watches:
Patek Philippe is renowned for its limited edition and highly intricate watches. For instance, the Patek Philippe Grandmaster Chime, released to celebrate the company’s 175th anniversary, sold for $31 million at an auction in Geneva.
Another example is the Patek Philippe Nautilus 5711, which has seen resale prices soar up to 900% over its original retail price.
More details here.
Rolex Watches:
Rolex is another brand that has consistently performed well in the collectibles market. The Rolex Daytona, once owned by Paul Newman, sold for $17.7 million. The rarity and provenance of such watches make them highly sought after.
More details here.
Failures Stories of Collectibles
Beanie Babies:
In the 1990s, Beanie Babies were a hot collectible item, with some fetching thousands of dollars. However, the market eventually crashed, leaving many investors with items worth only a fraction of their purchase price.
Tulip Mania:
One of the earliest recorded speculative bubbles, Tulip Mania in the 17th century saw the prices of tulip bulbs skyrocket before collapsing. This serves as a historical reminder of the risks associated with speculative investments.
8. Infrastructure Projects as an Alternative Investment
Infrastructure Projects
The last one, we want to introduce as one of the Alternative Investments is on investing in Infrastructure projects.
No wonder that infrastructure projects have emerged as a compelling alternative investment option, offering stable returns and contributing to societal development.
These include a wide range of essential physical structures and systems, such as transportation networks, energy facilities, water and sewage systems, and communication networks.
This blog will explore on the nature of infrastructure investments, their benefits, risks, and real-world examples of successful and challenging projects.
The Nature of Infrastructure Investments
Mostly, these types of investments are not target intentionally for retail investors, since it is for Big Corporations and Large Specialized Firms. However, it is wise for you to understand these types of assets are considered as Alternative Investments as well.
Well, let's see!
Long-Term Commitment:
Infrastructure investments typically require substantial capital and long-term commitments due to the large-scale nature of these projects. They often involve public-private partnerships (PPPs), where both government and private entities collaborate to fund and manage the projects. Here is the Reference Link for more info.
Essential Services:
These investments focus on essential services that support economic activities and improve quality of life. Examples include roads, bridges, airports, power plants, and hospitals.
For more info, you can explore here later.
Stable Cash Flows:
This will be an attractive option for Big Investors. Infrastructure assets are known for generating stable and predictable cash flows over extended periods. This stability makes them attractive to investors seeking steady returns. For more info, you can explore here.
Inflation Hedge:
Infrastructure investments often have built-in mechanisms to adjust for inflation, providing a hedge against rising prices. Click here the reference link for more info.
Benefits of Infrastructure Assets
Ok, now you've understood the nature of this investment assets well. Now, let's continue explore some of its benefits and drawbacks!
Economic Development:
Infrastructure projects drive economic growth by improving connectivity, reducing transportation costs, and enhancing productivity.
Job Creation:
These projects create jobs during both the construction and operational phases, contributing to local economies.
Social Impact:
Investments in infrastructure can lead to improved public services, such as better healthcare, education, and transportation.
Drawbacks of Infrastructure Assets
There are some drawbacks, and in fact, one of the first point is that it is not suitable for everyone. This type of huge investments and long-term vision, is mostly for Specialized and Large Firms & Corporations. So relax!, and let's continue some of its drawbacks!
Regulatory and Political Risks:
Changes in government policies or regulations can impact the viability and profitability of infrastructure projects.
High Initial Costs:
The substantial capital required for infrastructure projects can be a barrier for some investors.
Operational Risks:
Delays, cost overruns, and technical issues can affect the success of infrastructure projects.
Some Real-World Case Studies of Infrastructure Investments You can Learn from
London Heathrow Terminal 5:
The construction of Terminal 5 at London Heathrow Airport is a prime example of a successful infrastructure project. Completed in 2008, it significantly increased the airport’s capacity and efficiency, contributing to its status as one of the world’s busiest airports.
Renewable Energy Projects:
Investments in renewable energy infrastructure, such as wind farms and solar power plants, have seen substantial success. For instance, the Gansu Wind Farm in China is one of the largest wind farms in the world, providing clean energy to millions of people.
Berlin Brandenburg Airport:
The Berlin Brandenburg Airport project faced numerous delays and cost overruns, leading to a significant increase in the overall budget. Originally scheduled to open in 2011, it finally opened in 2020, nearly a decade late.
High-Speed Rail in California:
The California High-Speed Rail project has encountered various challenges, including funding shortfalls, legal battles, and environmental concerns. These issues have delayed the project’s completion and increased its costs.
CONCLUSION
Exploring alternative investments can open up a world of opportunities beyond traditional stocks and bonds. From venture capital and collectibles to infrastructure projects and more, these investments offer unique benefits and risks. By diversifying your portfolio with alternative investments, you can potentially achieve higher returns, hedge against market volatility, and invest in assets that align with your interests and values. However, it’s crucial to conduct thorough research and due diligence to navigate the complexities of these investments successfully.
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