Alternative investments surround almost all of our lives on a day-to-day basis, but when faced with the question of ‘what are alternative investments?’ many experienced investors can often be stumped for a definitive answer.
Whether it’s the current cryptocurrency phenomenon we’ve witnessed in recent years, which just this month made headlines after the market experienced a considerable crash at the hands of Elon Musk, or it be the popular venture capital based TV programmes which we see streamed daily across the globe, alternative investments are more closely intertwined with our everyday lives than many first expect.
But before identifying some popular examples of alternative investments, first it can be useful to find a common definition for this broadly assigned term.
What are alternative investments?
When addressing the question of ‘What actually are alternative investments?’ a very concise answer to the question could be any investment that doesn’t fall into the ‘conventional investment’ bracket.
Traditionally, conventional investments are investments made into cash, stocks or bonds, and so naturally the parameters of what actually make an alternative investment are highly flexible and can range across a whole host of industries and commodities.
Alternative investments have a low level of correspondence with traditional investments historically, which consequently make them less exposed to market conditions and in turn can make them particularly attractive to investors.
Not only can the lowered exposure to market conditions associated with some alternative investments make them an attractive prospect to investors, but so too can their potential for higher returns and wider scope for portfolio diversification when compared with their mainstream counterparts
Existing across a host of sectors in a range of forms, sizes and volumes, alternative investments allow investors to distribute their capital effectively across a wide range of potentially high-growth assets, further minimising risk.
But although alternative investments can provide a host of diversification and protection benefits to investors, what are some examples of alternative investments? And more importantly, how can investors take advantage of them?
1. Venture Capital
For experienced investors, one of the first topics covered when answering the question of “what are alternative investments?” is very often venture capital.
Other than its previously mentioned strong association with the media, venture capital is an extremely popular alternative investment type both globally and here in the UK - in 2020 the UK tech sector broke the record for its highest ever annual level of venture capital investment with £11.2bn being invested into UK tech companies 12 months alone.
But what is venture capital?
To define the term loosely, venture capital is a form of financing tailored for early stage companies to aid in further innovation and growth, commonly offered by private investors in return for a stake in a company.
Venture capital investments themselves can come in a range of forms depending on the method by which individuals - or institutions - invest, with tax-efficient investment methods being an increasingly popular choice selected by investors in recent years due to their host of attractive advantages.
Among the most popular tax efficient investment wrappers are the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), which offer investors the opportunity to invest in innovative, high growth early stage companies and start ups whilst benefiting from range of generous tax reliefs, including up to 50% income tax relief and zero capital gains tax on returns.
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2. Private equity
When defining what alternative investments actually are, the lines can often get blurred between similar investment types. And this can quite often be the case with private equity and venture capital.
Although the pair do share some notable similarities (namely the basis of both surrounds investing into companies in return for an equity stake, with the common goal of improving the value of the company before exit), they do differ in a number of ways.
Venture capital investments are primarily aimed at early stage and startup companies, often tech-focused, that will invite funding from a host of private investors usually in return for a total stake of less than 50%. Depending on the stage, institutional investors may be involved to a certain degree.
By contrast, private equity (PE) investments are often made with the goal of acquiring a majority stake of a company (i.e. 50%+), and are aimed at more mature companies. Although not a necessity, private equity opportunities are often seen in traditional industries, particularly where innovation is providing something new to said industries.
In turn, the main goal of private equity investments is often for PE firms or high net worth individuals to buy-out a well established business with the aim of resolving potential inefficiencies and ultimately selling the company for a profit.
A well-documented example that illustrates a private equity deal is the recent acquisition of global genealogy platform Ancestry last year by leading private equity firm Blackstone for a reported fee of $4.7 billion.
Contrastingly, an example of a venture capital deal focused at an earlier stage company in its growth phase could be one of upcoming SME bank B-North’s previous investment opportunities with GCV, created with the goal of further supporting the growing fintech firm as it prepared to disrupt the UK SME lending industry.
3. Peer-to-peer lending
Although a popular option for many investors on a high level, peer-to-peer (P2P) lending as a practice is only 17 years old, making it a relatively new and innovative form of alternative finance as far as the sector goes. As such, when prompted with the question of ‘what are alternative investments?’, even some of the most experienced investors may not be fully aware of its intricacies.
Often hailed as ‘financial matchmakers’, the purpose of a peer-to-peer loan is to connect an individual or business (borrower) with an individual (lender) and facilitate a loan sum in return for interest, repaid to the lender over an agreed period of time.
When initially introduced, P2P lending’s primary purpose was to facilitate consumer loans, but as the method has grown in popularity, now P2P loans can occur in the form of business as well as property loans - amongst other assets - all being facilitated through P2P platforms without the involvement of a middlemen such as financial institutions like banks.
Negating the need of the middleman in turn means lower overhead costs for platforms, which can lead to more generous target rates of return for experienced investors, with CARLTON Bonds offering experienced investors target rates as high as 7.75% through their property bonds.
When faced with low interest rates and a volatile stock market, alternative investments such as peer-to-peer loans can prove to be an extremely helpful tool in any investor's portfolio looking to diversify in a host of industries whilst targeting returns generally higher than their mainstream counterparts.
This form of alternative finance’s benefits can even be further enhanced by tools such as the IFISA, which allows investors to hold some P2P investments within the tax-efficient ISA wrapper, rendering all returns tax-free, bolstering investor benefits further.
An alternative investment experienced investors may be particularly familiar with given its considerable coverage in recent years is the more recently popularised cryptocurrency. Yet when finding a common definition of what alternative investments actually are, cryptocurrency can be seen as an example that drifts particularly far from the norm.
Cryptocurrencies - or “cryptographically secured digital representations of value or contractual rights that can be transferred, stored and traded electronically” as coined by HMRC - can otherwise be defined as digital, tradable currencies, often distributed across a large, decentralised networks of computers.
Made popular initially by what is now a household name in ‘Bitcoin’, this decentralised structure essentially means investors can make dealings directly with one another, negating the involvement of a centralised exchange.
This allows many cryptos to operate outside of the direct control of banks and central authorities, in theory rendering the alternative investment type less reactive to government directed fluctuations.
Though its resistance to governmental fluctuations is one of the reasons cryptocurrency has become popular with so many across the globe (Bitcoin’s unit price alone having rocketed from $1 in 2011 to over $60,000 just 10 years later), it is the same decentralised structure that makes the alternative investment so unpredictable and volatile.
Just this month the crypto market witnessed a considerable crash following a single Tweet from Tesla CEO Elon Musk, which stated that his company would no longer be accepting Bitcoin as a form of payment for their cars - this evidently high volatility and perceived lack of security being two of the most common sticking points for investors considering crypto.
Although certain “coins” can offer incredible rates of growth and return over relatively short periods of time, on the flip side of the coin, the considerable unpredictability and volatility of cryptocurrency can deter a large number of investors who may prefer the more predictable returns generally associated with fixed term P2P loans or considered venture capital EIS investments.
Which alternative investment is right for me?
As a whole, the right alternative investments for the right investor largely depends on their goals, circumstance and level of disposable income.
Venture capital investments may suit your portfolio if you’re looking for high growth investments with potentially higher levels of risk (albeit partly mitigated with tax reliefs in schemes such as the EIS) that allow you to support the next generation of businesses. Conversely, more established companies with private equity deals may moreso suit experienced investors with potentially less intensive growth goals.
Equally, if you’re an investor who is targeting steady, high interest returns and are willing to put away sums of capital for predictable, fixed periods of time, peer-to-peer loans may suit your portfolio, and in contrast to that, those happy to adopt much higher levels of risk and volatility for potentially more immediate astronomical returns may prefer cryptocurrency.
Regardless of personal situation or goals, diversifying your investment portfolio with a range of investments - alternative or not - should be a key activity for any investor looking to manage risk favourably. And where the aforementioned types are just four examples that illustrate what alternative investments actually are, there are a whole host options available that could fit your portfolio perfectly.