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Alternative investing: Is it right for you?

Jamie McGeachie
Friday, October 07, 2016

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By Jamie McGeachie

When most people think about investing, traditional methods such as stocks and bonds usually come to mind. In the past, these have been the main options available to everyday investors.

While diversification is possible through these investments, the drawback is that their overall performance is linked to the global economy. That means they tend to rise or fall in tandem, and there’s little protection against losses in the event of a global economic crisis.

Alternative investments

This has led to investors searching for other options with returns that aren’t correlated with stocks and bonds to enhance portfolio diversity and provide protection from traditional market fluctuations. These options are classified as alternative investments.

The term ‘alternative investments’ applies to a broad range of investment vehicles. Some examples include hedge funds, currency, private equity, venture capital, precious metals, fine art, wine, coins, collectables, oil and financial derivatives.

Traditionally, many of these alternatives were only available to institutions or high-net-worth individuals. However, with increasing investor appetite for alternative investment methods – particularly following the 2008 global financial crisis – avenues for alternative investments began to open up. These included various retail managed funds that pooled investor money to enter the above markets, and peer-to-peer lending.

In Australia, Investors Central meets this need by offering investors the opportunity to purchase a product called preference shares.

Preference shares

Redeemable preference shares are debt instruments where the company pays the investor monthly interest in arrears on the amount invested. The invested money is used to fund motor vehicle loans company Finance One, which in turn, lends the money to individuals and small business owners seeking to purchase a car.

Because these kind of loans attract relatively high interest rates, the returns to investors are generally better than that offered by banks. The invested funds are spread out across many loans, helping to minimise the risk of loss from defaults. With a minimum entry price of $25,000, this kind of alternative investment is firmly within reach of individual investors.

Pros and pitfalls

Alternative investments come with their own set of unique risks and advantages. Their main benefit is that they offer a low correlation with stocks and bonds, so they tend to perform best at times when the world markets are struggling.

As part of a balanced investment portfolio, they can increase long-term returns, especially during repeated periods of financial uncertainty. Gold, for example, has had an almost zero correlation with stocks and bonds during the past 40 years. Alternative investments may also result in lower transaction costs than standard ones, as they tend to be turned over less frequently.

On the flip side, some alternative investments may be less liquid than traditional stocks and bonds. That means there’s a smaller market in which to sell them. The values of commodities like oil, crops, or livestock can be volatile and affected by aspects such as global supply and natural disasters. It can be difficult to gauge the likely performance or current value of rare items, such as coins or stamps, because there’s a limited history of previous trading. During times of strength in the global economy, alternatives are often out-performed by stocks and bonds.

Bottom line

For all these reasons, it’s vital that you do your homework before deciding which alternative investment is right for you. Ideally, you want to focus on investments that have the greatest level of negative correlation to your existing portfolio.

Also factor in your investment timeframe i.e. Are you looking for long-term, or short-term returns? Assess your tolerance for risk, and bear that in mind when considering more volatile investment vehicles. If you’re looking to buy into a managed fund, ensure you thoroughly investigate the fund manager and the performance of the fund itself. Also make sure you’re fully aware of any management fees that may apply. It’s highly advisable that you engage the services of an experienced financial adviser who can assess the suitability of your chosen alternative investments in relation to your current portfolio.

There’s an ever-growing range of alternative investment options available to ordinary investors, and their strategic use within your investment portfolio can provide you with both a healthy long-term return and protection against a bear market. But remember to speak to your financial adviser about whether alternative investments are right for you.

This report contains general financial product advice which does not take your personal objectives, circumstances or needs into account. You should consider these factors before you make an investment decision and if you are unsure you should seek professional advice.

Published: Friday, October 07, 2016

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