Diversification is one of the most crucial elements in investing. Building a portfolio that includes alternative investments, such as art, may be risky but it can also be very profitable in the long term. To know more, read this article on MSN:
Many alternative investments carry high minimum investments and are rather complex if you don’t understand them well. | © (Jamie Grill/Getty Images)
If you’ve got any sort of portfolio, you know what stocks and bonds are.
Those two asset classes dominate the typical retail investor’s portfolio, but alternative investments – non-traditional investments that tend not to be correlated to the performance of stocks and bonds – aren’t given much of a thought.
Perhaps they should be.
Here’s a look at the alternative investments landscape, what it offers, and some specific types of investments that, if nothing else, are certainly more interesting than Procter & Gamble (NYSE: PG) stock and municipal bonds.
Hedge funds. Hedge funds are the most encompassing type of alternative investments. Investors pool their funds together and a manager deploys their capital in an effort to achieve “alpha,” or a return that beats a certain benchmark.
When you bring up alternative investments, the first thing many financial professionals think of is hedge funds, which themselves often invest in other non-correlated, non-traditional assets.
Still, hedge funds have a few defining characteristics of their own.
“Most alternatives tend to be illiquid, so if you’re looking for liquidity they’re not the right tool for you,” says George Sullivan, global head of alternative investment solutions for State Street. “Hedge funds have liquidity dates that are monthly, as opposed to mutual funds which would be daily.”
Many also require extremely high minimum investments, making them impossible for the average investor to afford. In fact, you’ve got to be an accredited investor, which means you have to meet stringent requirements like making $200,000 for two straight years (and believing you’ll do so again this year) or having a net worth of $1 million – excluding your primary residence.
Here’s a look at some of the more interesting alternative investments – some of which hedge funds themselves will invest in – that are actually accessible to the average investor.
Music royalties. RoyaltyExchange.com is an auction website that connects buyers and sellers in (mostly) the music royalties industry. Artists looking to raise some quick cash can take to the website to sell their future royalties. Specifics vary from auction to auction, but investors can then get paid every time a certain song or portfolio of songs is played on the radio, streamed, or heard on TV.
Recent performance rights to “See You Again” by Wiz Khalifa featuring Charlie Puth sold for $102,000 on Royalty Exchange. The song’s trailing 12 months earnings were $11,372. That’s on the expensive end for Royalty Exchange, whose last 30 auctions went for a median price of $29,750.
So what makes music royalties an interesting alternative investment opportunity?
“Royalties actually offer a good degree of yield,” says Antony Bruno, director of communications at Royalty Exchange. “If you buy at the right price you can get yields far greater than what you can get from bonds or savings accounts or other types of investments.”
Bruno also credits the consistency (quarterly payments), stability (older assets reach a “plateau level” of earnings you can generally rely on), and royalties’ divergence from broader market returns as reasons to invest.
“Stock market crashes? That doesn’t affect anything – you still get paid your royalties. There’s really no connection between the two. Having an uncorrelated asset that’s both consistent, stable, and has a high yield – you put all that together and you’ve got a pretty powerful opportunity,” Bruno says.
Cryptocurrencies. Unless you’ve been sleeping under a rock, odds are you’ve heard of bitcoin. While bitcoin is certainly the most popular cryptocurrency, it’s far from the only one.
The recent raging bull market in this asset class has brought it to the front pages of many financial publications, and for good reason: aside from its potential as a seamless payment method, it also holds promise in fields like law and health care, where the blockchain can be used to permanently log contracts and medical records.
“Alternative assets by definition have less liquidity than traditional assets, but they also offer massive upsides if you can sacrifice short-term flexibility,” says Zach Hamilton, managing partner of General Crypto, a long-only hedge fund that only invests in cryptographically secured assets. “Cryptocurrencies are extremely liquid, negating most of this downside.”
Hamilton adds, “Several studies have been done, including our own internal analysis that show cryptocurrencies are uncorrelated with the general market, including commodities like oil and gold.”
Real estate. While real estate can certainly correlate with the broader economy, it’s still been a remarkable investment opportunity over the long-term. For many Americans, real estate ends up being the largest single investment they ever make when they buy their primary residence.
Of course, there are ways to invest in real estate aside from literally buying houses. One of the more popular and accessible ways to do this is through real estate investment trusts.
“I like REITs because they give us an opportunity to invest in real estate without having the hassles of being a landlord or financing a project,” says Tom Vilord, president and CEO of Wall Street Value, an investor education company, and WSV Capital, a hedge fund.
Like stocks, REITs are publicly traded, and due to their tax structure, they’re legally required to pay 90 percent of their earnings back to their investors, which means they’re known for their extremely high yields.
Exact yields vary, but REITs often fall between 5 and 10 percent, and sometimes yield even more. Another great thing about REITs is you can get granular when it comes to the type of properties you’re investing in. Options include single-family homes, commercial real estate, health care facilities and other opportunities.
Other options, and a word of caution. There are still more interesting and potentially lucrative alternative investments that share some typical (and attractive) characteristics like not being correlated with the stock market and an ability to give portfolios a measure of diversity.
Peer-to-peer loans, private equity, art, luxury cars and other collectibles are additional options for investors looking to mix things up a little bit.
However, to insinuate that alternatives are all upside and no downside is, of course, misleading and untrue.
“They tend to be private in their structure as opposed to public, they’re generally illiquid and aren’t as regulated as more traditional investments,” Sullivan says.
Before turning to alternative investments, for instance, you should likely make sure you have a nice traditional portfolio of stocks and bonds (or funds that hold them) first. This is a very broad asset class that’s far more opaque than the stock market; stocks are still clear winners when it comes to average historical returns.
Aside from their traditional illiquidity, many alternative investments carry high minimum investments and are rather complex instruments that could leave you holding the bag if you don’t understand them well. There are plenty of exciting and unique ones to be sure – but then again excitement can’t buy you a retirement home in the Bahamas.
Be wise, and consult a financial advisor before taking a serious plunge.