Hitherto the domain of Financial Institutions and Hedge Funds, alternative investments
have become more mainstream in the recent years. From HNIs to retail investors,
alternative investments are gaining popularity among all.
what are Alternative Investments?
Simply put, Alternative Investments are those investments which do not include a
long position in traditional assets such as bonds, equities and mutual funds.
While evaluating investment options, you may have heard about diversification and
risk-return trade-off. Diversification or keeping a variety of different assets
in your portfolio helps reduce the volatility of returns from your holdings and
protects your portfolio in case one type of investment loses money while another
remains stable or gains.
Diversification: Alternative investments are non-traditional
ways to broaden your portfolio, and they might help you make money when traditional
investments are losing ground. The investment approach of alternative investments
are very different from that of traditional equity or fixed income investments.
This approach may involve holding both long as well as short positions, using hedging
strategies and also investing in illiquid investment vehicles. Investors using alternatives
may also have a goal of achieving a specific level of absolute return as opposed
to relative performance versus an index.
Due to their low correlation to traditional investments, alternative investments
can potentially enhance diversification and reduce risk. As they are more flexible
and offer a wider investment opportunity, they can potentially enhance return and
can be used to hedge certain portfolio exposures, thereby reducing concentration
risk. Due to this their risks and characteristics are different from those of traditional
investments. On the other hand, they are often less liquid, mostly in periods of
stress; they are generally known to be more complex and less transparent, which
makes them difficult for untrained investors to understand.
While alternative investments on their own may have higher volatility than more
traditional investments, particularly fixed income, they typically have low correlations
to more traditional asset classes. As such, their inclusion in an investment portfolio
tends to result in overall lower volatility.
Protection in Economic Downturns: Traditional equities, bonds
and mutual funds are subject to bull and bear market cycles. Real estate too has
its downturns. The 2008 bear market dropped in tandem with severe corrections in
the real estate sector as well, leading to widespread erosion of investor wealth.
During this time, however, some players in alternative investments managed to post
Higher Returns - Because they have a wider universe for investment and do not have
some of the same investment constraints (can short and hedge), alternative investments
have better potential for higher returns than traditional investments. Since investors
are looking to increase expected returns or have achieved their investment targets
in traditional assets, optional avenues into alternative investments are gaining
Risks associated with Alternative Investments There are
several risks associated with alternative investments above and beyond those typically
associated with traditional investments. Hence, investors should select only those
investments where the underlying risks are well understood.
- Complicated Structures - they characteristically have more complicated
structures in their attempt to achieve consistent or higher returns, may be difficult
to understand for the lay investor and hence call for higher due diligence.
- Less Liquid - Certain types of alternative investments may have
- Higher Fees - Given their specialized nature and objective of
providing higher absolute returns as compared to traditional investments, they typically
charge higher fees.
What are the Alternative avenues available today?
Here we keep our discussion limited to examples that are more readily available
to investors in India and are relatively easier to understand and access. These
are classified as Alternative Investments given that these avenues do not frequently
fall under the consideration set for most investors and go beyond stocks, bonds
and mutual funds. However, they have their own merits and it may be helpful to gain
an understanding into these instruments or investment vehicles.
Exchange Traded Funds (ETFs)
Real Estate Investment Trusts (REITs)
The following sections provide brief introductions to the four categories.
Exchange Traded Funds (ETFs)
are essentially Index Funds
that are listed and traded on exchanges just like stocks. Moreover, they can be
bought or sold anytime during the market hours at prevailing price, through terminals
across the country. An ETF is a basket of stocks that reflects the composition of
an Index, like CNX Nifty or BSE Sensex. A key differentiating factor in favour of
ETFs is that their expense ratio is lower, therefore its cost of portfolio administration
is even lower than the index funds. It is one such investment option that helps
you beat inflation.
Average returns on equities in the last 10 years have been in the around 20% compounded
annually, while on fixed income instruments it has been 6-7% (see chart below).
Inspite of the higher return delivered, investing in equities has its own challenges.
On the other hand while fixed income instruments like government bonds or fixed
deposits are relatively safer, the returns delivered may not beat inflation. Whereas,
ETFs (refer GS Nifty BeeS in the chart below) has delivered returns comparable to
benchmark indices and are much simpler for the lay investor to understand and invest
Globally, ETFs have opened a whole new panorama of investment opportunities to retail
as well as institutional money managers. Because of its distinct advantages, ETFs
have emerged as one of the most popular asset classes amongst the Investor community
across globe, including India.
However, as every coin has two sides, there are also some disadvantages associated
with ETFs too. For instance, underlying volatility, SIP in ETFs is not readily available,
you can't automatically re-invest your dividends and comparatively lower liquidity
as the market has still not caught up on the concept.
Real Estate Investment Trust (REIT)
is a company that
owns or funds income-producing real estate investment. It offers regular income
streams, diversification and long-term capital appreciation to all types of investors.
REITs usually pay out all of their taxable income as dividends to shareholders.
In turn, shareholders pay the income taxes on those dividends. Under REITs, the
investors benefit a share of the income earned out of real estate investment, wherein
they do not have to actually buy or finance a property to invest.
REITs let investors to put in money in portfolios of large-scale properties through
the purchase of stocks. REITs are generally traded on major stock exchanges; however,
there are many REITs which are public, non-listed and private. The two main types
of REITs are Equity REITs and Mortgage REITs. Equity REITs make income through the
collection of rent on, and from sales of, the properties they own for the long-term.
Mortgage REITs, as name suggests, invest in mortgages or mortgage securities tied
to commercial and/or residential properties.
are homogeneous goods available in large
quantities, such as energy products, agricultural products and metals. They can
be categorized on the basis of their emphasis on futures contracts, physical commodities,
Futures contracts refer to traditional futures contracts, as well as closely related
derivative products, such as forward contracts and swaps. Futures contracts are
regulated distinctly and have well defined economic properties. For example, the
analysis of futures contracts typically emphasizes notional amounts rather than
the amount of money posted as collateral or margin to acquire positions.
Commodities as an investment class refer to investment products with somewhat passive
(i.e., buy-and-hold) exposure to commodity prices. This exposure can be obtained
through futures contracts, physical commodities, natural resource companies, and
A recommended approach to investors new to commodities, is to start with research
on selected commodities and invest in smaller contract sizes.
are synthetic investment instruments
specially created to meet specific needs that cannot be met from the standardized
financial instruments available in the markets. Structured products can be used
as an alternative to a direct investment, as part of the asset allocation process
to reduce risk exposure of a portfolio, or to utilize the current market trend.
Structured products are instruments created to exhibit particular return, risk,
taxation, or other attributes. These instruments generate unique cash flows resulting
from a partitioning of the cash flows from a traditional investment or by linking
the returns of the structured product to one or more market values.
lets you invest in up-and-coming companies
that are not yet public or listed on stock exchanges. They can give excellent returns;
however they call for thorough research into the potential of the company's business
and patience to hold on to one's investment since money might be tied up for years
until an exit opportunity is available. Exit opportunities usually come through
the company's listing or through sale of one's holdings to another private investor.
How Can Way2Wealth Assist?
We scan the market place for well performing alternative investment funds (AIFs)
and new opportunities on a regular basis. This exercise helps our clients evaluate
the best performing funds for their investment consideration. We regularly interact
with AIF managers and pass on relevant updates to interested clients. We monitor
the performance of the short listed AIFs to ensure the efficiencies can be measured.
Periodic reporting on the performance of the AIFs are prepared and shared with clients.
We advise clients on timely entries & exits into/out of the AIFs and can negotiate
good terms for the investing clients.
With specific reference to the avenues mentioned earlier, here are some pointers:
- ETFs- Investing in ETFs is quite simple and only requires a
simple trading/investment account with a broker like us. Investors can buy and sell
Index or Gold ETFs similar to stocks.
- REITs- We bring quality issues to clients after in-house due
diligence on the investment worthiness of REIT issuances in the market.
- Commodities- We can facilitate delivery settlement of exchange
traded commodities. Given our knowledge and expertise in physical commodities, we
can advise and execute procurement and warehousing of physical commodities and if
desired, arbitrage physical commodities using futures contracts in commodities traded
on the exchange platforms.
- Private Equity- Through our close relationships with investment
bankers, we bring private investment opportunities from time to time for our HNI
clients, who have some background to investing in this area.