Investments are subject to market risk.
Where have we heard that before? 🤔 While you try to recall the hundreds of mutual fund ads running on television, we assume you are at the very least curious about “alternative investments” considering you stumbled upon this article.
There are two reasons we started the piece with that line: 1) we wanted your attention, and more importantly,
2) to highlight that alt investments are inherently more risky than their traditional counterparts.
As any seasoned investor would tell you, every investment you make has to be evaluated in a 2X2 matrix of risk and return. In simple words, the more risk you take, the higher your returns are likely to be, and vice versa.
To understand this better, let’s begin with what the different types of investment risks are.
Liquidity Risk
The primary challenge posed by several alts is the lack of liquidity.
What that means is, you can’t withdraw your invested money whenever you want. Imagine this: you are an angel investor who has put in money into an early-stage startup.
Unlike let’s say an investment into a publicly-traded company, you cannot ask for the money back until there is a liquidity event such as an acquisition or an initial public offering because there are no centralized marketplaces connecting buyers and sellers.
Inherent Volatility
Volatility refers to the sensitivity of an asset to macroeconomic and geopolitical factors.
For example, government bonds are least volatile while there are cryptocurrencies on the other end of the spectrum that are highly volatile.
Credit Risk
When investors lend money to companies or governments by purchasing bonds, for example, they are taking on credit risk.
The risk is that the borrower may not be able to pay back the principal and/or interest as promised, resulting in a loss for the investor.
Picture this: you invest in a debt fund which, in turn, invests in corporate bonds. You are essentially lending your money to corporations in that case. If the company fails to operate successfully and make enough money to return the loan, you are at the risk of losing your money.
Creating an antifragile portfolio
An antifragile portfolio is one that is designed to not just survive but thrive during times of uncertainty, volatility, and stress.
The key to creating one?
Have adequate diversification in uncorrelated assets.
By investing in assets that have a low or negative correlation with each other, their price or value moves independently of each other. Think of it this way: some assets, such as stocks and bonds, tend to move in tandem with the broader market, while others, like commodities or real estate, may perform better in certain economic conditions or have different drivers for their performance.
One good example is, how during periods of economic uncertainty or market volatility, investors flock to gold as a safe investment, taking the price of the commodity up.
Where do you stand?
Based on age and stage in life, you should have a portfolio that achieves both your ongoing liquidity requirements and long-term financial goals.
Throwing in a few alts into the mix may be a good way to achieve adequate diversification, and your return objectives.
A 2022 report by research firm Cerulli Associates found that 44% of US institutional investors wanted to increase their allocation to alternative investments. By contrast, only 24% of those surveyed said they plan to increase their exposure to equities.
Some alts you can invest in
High-Yield Debt
A popular alt to have become widely accessible in the last few years, high-yield debt refers to instruments that are inherently more risky than traditional debt instruments, but with obviously higher upside.
One of the more popular forms of HYD is revenue-based financing where investors lend money to a company in exchange for a percentage of future revenue.
For example, let's say a software company needs $100,000 to expand its product line. It goes to a facilitating platform that then brings together investors to put in the money in exchange for 10% of the company's monthly revenue until the investors receive a total of $150,000.
Lease financing is another popular way for startups to manage cash flow by borrowing money against fixed assets (laptops to logistics), thereby providing investors a high IRR (albeit riskier) income stream.
Real Estate
If you are in India, chances are, you’d have had your fair share of being asked to make a home or buying a piece of land.
Investing in real estate has the potential to offer both capital gains and rental income. Real estate values and rental prices tend to rise over time, making it a valuable asset class for portfolio diversification and an effective hedge against inflation.
For those who wish to have exposure to real estate in their portfolio without having to shell out a significantly large sum upfront, investing in real estate investment trusts (REITs) is an option.
REITs offer you a chance to have fractional ownership in a commercial property at palatable ticket sizes.
Startups
Shark Tank, anyone? While the show may have made startups and entrepreneurs mainstream, you don’t need to be a “shark” to be able to invest in startups.
If you are a part of the startup ecosystem, it's likely that you have connections who are already angel investors and/or have access to early funding rounds for new startups.
To begin with, make it known within your online and offline networks that you are open to investing in startups as an individual.
Alternatively, you can explore online platforms that serve as intermediaries between investors and startups. Keep in mind that these platforms typically charge a fee for facilitating the process and may also require a share of the potential returns.
Crypto
Known for their extreme volatility, several cryptocurrencies have taken a severe beating in the post-pandemic era, leading to widespread speculation about their legality.
But as the asset class matures, and public perception improves, it may not be such a bad thing to have some eggs in this basket.
