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Broadly speaking, “alternative investments” refer to assets other than cash, equtiies and bonds – such as property and private equity. However, alternative investing refers to a broad range of potential investments. How can you choose the best ones for your portfolio? In this guide, we offer a summary of different alternative investment types in 2022-23, some of the advantages and disadvantages as well as thoughts on how to integrate them effectively into an investment strategy. To find out more about our EIS and other investment opportunities, visit our portfolio page here. To enquire regarding our latest projects and funding (for investors and founders, respectively), you can reach us via:
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What are alternative investments?
The “bread and butter” for retail investors is typically a mixture of cash, equities (publicly-listed shares) and bonds (e.g. gilts; UK government bonds). Broadly, these “traditional” investments are bought and sold on a public exchange such as the London Stock Exchange. As such, they are highly regulated and often involve lower risk compared to investments in, say, startups. On the other hand, alternative investments are usually privately-owned assets which may (or may not) be traded on an official exchange. Sometimes, they are traded “over the counter” or directly between a buyer and seller – such as during a property sale.
Types of alternative investments
Alternative investments cover a wide range of asset types. Private credit, for instance, involves an investor lending money directly to a business (outside of public markets, unlike corporate bonds). Currently, about 2,000 firms across the UK receive £100 billion from private lenders. A related category to this is peer to peer (P2P) lending, where investors can group together to lend money to a person or business via an online platform. This can be done via an Innovative Finance ISA, for instance, allowing any capital gains to be generated without tax.
Private equity is another important alternative investment route. Here, an investment fund will seek to acquire (or invest in) private companies which are not publicly listed. On a smaller scale, angel investors can invest in very early-stage private businesses, asking for an equity stake in exchange. Hedge funds, on the other hand, represent limited partnership of private investors who entrust money to professional fund managers to invest in alternative assets on their behalf (often using “leveraging” and other “risky” strategies to try and achieve above-average returns).
Some final alternative investments include property, collectibles and cryptocurrencies. The buying, selling and financing of properties may include using REITs (real estate investment trusts, which are publicly-traded). Types of collectibles might include art collections, fine wines, vintage cars, coins and collectable cards. Cryptocurrencies are digitally-based currencies that use blockchain technology to provide a “trustless” payment system. Here, an investor can buy certain cryptocurrencies in the hope of selling them later for a profit or put money into “miners” (who “solve” the equations involved with crypto transactions).
How to approach alternative investments
Many alternative investments are not regulated and so offer fewer protections to investors. The Financial Services Compensation Scheme (FSCS), for instance, covers you up to £85,000 for cash held in a bank (or banking group). Similarly, if a provider is regulated by the FCA (Financial Conduct Authority) and advised you on a regulated investment – such as an equity fund – then if the firm fails you may be eligible for compensation via the FSCS.
With that said, alternative investments do often offer higher potential returns and do not mean you skip over the due diligence. Indeed, many regulated firms offer alternative investments on their platforms alongside traditional ones. Knowing some of the benefits and drawbacks of the various options can help you determine which one(s) may be suitable for your portfolio:
- Private lending (including P2P). Here, you could benefit from a regular income stream from the borrower’s repayments – with interest. However, you will need to do a careful risk assessment of different companies to determine whether their business model is viable and you have a strong chance of getting your money back.
- Private equity & hedge funds. These firms may have access to knowledge, skills and investment opportunities that you may not be privy to on your own. They can be volatile, however, and involve high illiquidity – making it difficult to turn investments into cash.
- Angel investing. If you are looking for high potential returns within a short timeframe and you like early-stage businesses, then this can be a great option. One potential drawback is that the business may not be profitable for some time and its business model may not yet be proven, making it a higher-risk investment.
- Property. Gives you the benefit of a “tangible” asset class with a strong history of growth within various property markets. Yet these investments can be difficult to sell quickly and your investment will be affected by strong forces outside your control (e.g. interest rates).
- Collectables. Can be a very lucrative way to invest if you know the specific collectable well – such as comic books or fine art. However, there is no guarantee that what you see as a collectable will be widely seen as such in the decades ahead. You also have to physically store many of these items, which may incur costs and also risk of theft/destruction.
- Cryptocurrencies. An exciting, new area of currency investing which holds an exciting future for the world of payments. Yet there are many to choose from, making it a very cluttered marketplace where it is difficult to differentiate. There is also political risk (i.e. government shutdown) and technology risk – such as algorithm failure.
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