Alternative Investment - Explained
What is an Alternative Investment?
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Table of ContentsWhat is an Alternative Investment?How Does an Alternative Investment Work?Alternative Investments for Diversification and HedgingAlternative Investment Costs and Tax ConsiderationsAccessing Alternative Investments Through ETFsRegulation of Alternative InvestmentsAcademics Research on Alternative Investment
What is an Alternative Investment?
An alternative investment refers to an investment that invests in assets order than the traditional asset classes. This fund or investment goes beyond traditional methods and assets when investing. Examples of alternative investments are hedge funds, venture capital, private equity, real estate investment trusts, managed futures, derivatives contracts, commodities, and others. Alternative investments invest in assets beyond the traditional stocks, bonds, gold, timber, and cash. Alternative investments are often held by institutional and accredited investors who have a high net-worth. Given that alternative investments are capital-intensive, and are complex in nature, individual investors might not be able to handle them.
How Does an Alternative Investment Work?
Unlike other traditional investments that are highly regulated, alternative investments have limited or no regulations which mean any investor that invests in them must be ready to take all the risks involved. Due to the lack of regulation of alternative investments, they are exposed to investment scams and fraud. Investments of this nature also have high free structures different from traditional investments. Alternative investments are also less liquid when compared to conventional assets like stock and bonds. Furthermore, alternative investment transactions are complex and unique, it, therefore, it becomes difficult to know the actual value of these investments.
Alternative Investments for Diversification and Hedging
It is important to know that alternative investments have traits different from conventional assets. The uniqueness of these investments makes them suitable for the purpose of diversification. Alternative investments are often handled by institutional investors given that they require large funds and adequate monitoring. As a good way of achieving portfolio diversification, many institutional funds have begun to separate a percentage of their portfolio to accommodate alternative investments. Investors who invest in these investments must, however, perform due diligence in order not to fall victim to investment fraud.
Alternative Investment Costs and Tax Considerations
There are certain tax benefits that alternative investments offer when they are held over a long period, investors are required to pay lower capital gains and lower tax as against conventional or short-term investments. Aside from tax benefits, alternative investments have lower transaction costs, however, investors are required to pay a high upfront fee at the initial stage.
Accessing Alternative Investments Through ETFs
Alternative investments are typically designed for institutional investors or investment firms. Individual or retail investors invest in conventional assets most times such as stock, bond, real estate, gold, and precious metals. However, there are specific ways retail investors access alternative investment, this is through ETFs in which these investors can access different categories of investment.
Regulation of Alternative Investments
There is limited regulation on alternative investments, the legal position of regulatory bodies when it comes to alternative investment is quite unclear. Increasingly, alternative investments are subject to the regulation of the DoddFrank Wall Street Reform and Consumer Protection Act. Despite this regulation, they operate at laxity as compared to traditional investments. For instance, the Securities and Exchange Commission (SEC) and the Financial Services Regulatory Commission oversee mutual funds and ETFs, but in the case of alternative investment, there is an absence of strict regulation.
Academics Research on Alternative Investment
- Alternative investment strategies for the issuers of equity linked life insurance policies with an asset value guarantee, Brennan, M. J., & Schwartz, E. S. (1979). Alternative investment strategies for the issuers of equity linked life insurance policies with an asset value guarantee.Journal of Business, 63-93. In an earlier paper we derived an investment strategy for an insurance company which would eliminate the risks associated with the sale of equity linked life insurance policies with an asset value guarantee. In this paper we explore whether this riskless investment strategy has any practical utility, in view both of the impossibility of effecting continuous portfolio adjustment and of the costs which must be incurred in making discrete portfolio adjustments. By simulating the returns to issuers of these policies under different investment strategies, we find that discrete approximations to the riskless investment strategy do indeed reduce considerably the risk of extreme losses.
- Social reporting by companies listed on thealternative investmentmarket, Parsa, S., & Kouhy, R. (2008). Social reporting by companies listed on the alternative investment market.Journal of Business Ethics,79(3), 345-360. While the existing literature focuses on the disclosure of social information mainly by large companies, this paper concentrates on the disclosure of social information by small- and medium-sized companies (SME) listed on the Alternative Investment Market (AIM) in the U.K. The paper investigates the prevalent view that SMEs are unlikely to report social information due to their financial constraints and the perception that they have very little social conduct on which to report. Our overall evidence illustrates that, contrary to this view, SMEs report social information regardless of their financial constraints, most likely in the same manner as large companies do, because they realise the significance of social reporting in establishing and retaining their corporate reputation.
- Returns onalternative investmentmedia and implications for portfolio construction, Robichek, A. A., Cohn, R. A., & Pringle, J. J. (1972). Returns on alternative investment media and implications for portfolio construction.The Journal of Business,45(3), 427-443.
- Benefits and risks ofalternative investmentstrategies, Amenc, N., Martellini, L., & Vaissi, M. (2003). Benefits and risks of alternative investment strategies.Journal of Asset Management,4(2), 96-118. As a result of the complex trading strategies they implement, and the full flexibility they have with respect to their ability to use derivatives and trade in illiquid markets, hedge fund managers, even those following zero-beta non-directional strategies, are exposed to a variety of risk factors (volatility risk, liquidity risk, credit risk, etc) in a potentially complex manner. This paper argues that a proper understanding of hedge fund risk extends much beyond a straightforward measure of linear exposure to market risk, and provides a detailed analysis of how modern portfolio theory allows the presence of these rewarded sources of risk to be accounted for when assessing the performance of hedge fund managers. The contrasted exposures of hedge fund managers to a large number of risk factors poses serious challenges to the investor, as it requires the use of appropriate techniques dedicated to their measure and control. In contrast, it is argued that this is also the driving force behind the diversification benefits investors enjoy when investing in hedge funds. The main message can be summarised as follows: the benefits and risks or alternative investment strategies are two facets of the same coin.
- Securities regulation in low-tier listing venues: The rise of theAlternative InvestmentMarket, Mendoza, J. M. (2008). Securities regulation in low-tier listing venues: The rise of the Alternative Investment Market.Fordham J. Corp. & Fin. L.,13, 257.