Alternative investments are any assets that fall outside of the traditional financial instruments like stocks, bonds, and cash. They include investments in hedge funds, real estate, private equity, private debt, precious metals, wine, art, stamps, or cryptocurrency.
Alternative investments have been, traditionally, somewhat restricted to high net worth individuals. They are, though, becoming more common and mainstream as time goes on – more and more investors are adding alternative investments to their investment portfolios. According to research from Preqin, the alternative investments industry is expected to reach over $14 trillion in assets under management by 2023, growth of 59% from the end of 2017.
It’s important that investors diversify their portfolios, spreading the risk across a variety of asset types. Alternative investments are one way of doing exactly this. They usually have a low correlation with traditional asset types, like stocks and bonds. Therefore, they function as hedges against investments in traditional securities.
Alternative investments can also generate higher returns than mainstream assets. However, it is important to know that alternative investments have high purchase costs and low liquidity. As a result, investing in alternative assets requires a distinct set of skills, knowledge, and risk tolerance.
Forms of alternative investing vs ETF investing
While different forms of alternative investing may be appealing to investors, they are not everyone’s cup of tea. Investing in alternative assets means high minimum investments, more fees and lower liquidity when compared with conventional financial assets. Moreover, due to lack of regulation, alternative investments are also prone to investment frauds and scams.
On the other hand, exchange-traded funds (ETFs) can be a middle ground between the two. ETF investing is not as traditional as investing in stocks and it provides good exposure to alternative assets. Investors can choose to invest in ETFs that specialise in alternative investments, too. ETF investing offers the best of both worlds by letting investors experience alternative investing, without being exposed to illiquidity and other atypical risks – ETFs are regulated and easy to manage and sell.
For instance, investors can invest directly in private equity, but it involves a lot of initial capital, along with high risks and low liquidity. On the contrary, the same investors can invest in ETFs that track the performance of alternatives indices. For example, iShares Listed Private Equity UCITS ETF that tracks the performance of the S&P Listed Private Equity Index or Xtrackers LPX Private Equity Swap UCITS ETF that tracks the performance of LPX Major Market Total Return Index.
Why investing in ETFs is a good alternative
ETF stands for exchange-traded fund. A fund pools investors’ money and invests it into securities and assets. In the case of alternative asset ETFs, they own underlying assets like gold, foreign currency, cryptocurrency, private equity, or real estate, and divide the ownership of these assets into shares. These shares are then traded on the exchange. Thus, these assets become indirectly owned by investors.
Investing in ETFs is a popular alternative to investing in both traditional assets and alternative assets directly for the following reasons:
- Diversification: ETF investing offers similar diversification to the investment portfolio as investing in alternative assets. Investors get exposure to a variety of assets and can spread their risk across different sectors, countries, strategies and asset types.
- Liquidity: Another significant advantage of investing in ETFs is liquidity. ETFs trade throughout the day on major exchanges, just like stocks. Thus, investors can access alternative investments without the risk of getting locked in. They can jump in or jump out whenever they want to, and can also sell ETFs short or on margin.
- Cost-effectiveness: ETF investing is more cost-effective than investing in traditional assets and alternative assets. Investing in individual stocks leads to an accumulation of transaction fees for each stock, while trading one ETF that invests in a basket of stocks is considered as one transaction. Additionally, the management fee and expense ratio for ETFs is lower than that of mutual funds as ETFs are not actively managed.
- Simplicity: ETF investing is simpler to understand than the complex structure of alternative investing. The design is simple and can be easily comprehended by individual investors without the need to seek professional help. Therefore, the barrier to entry is lower than it is with alternative investing.
How to have success investing in ETFs
ETF investing is an excellent way to enter the world of alternative investing. ETFs give you diversification, liquidity, simplicity, and cost-effectiveness, without the complicated structure and high fees of truly alternative assets. So, they represent effective vehicles for both traditional and alternative investing.
However, ETF investing also needs skills, know-how, and consideration of various parameters for successful returns. The following factors must be considered to have success investing in ETFs:
- Basic information: The first step to success is, simply, knowing what you’re investing in. You should look at which index the ETF is tracking, how long it has been around and how it’s constructed. Knowing whether the ETF is actively or passively managed is also important. Passive ETFs look to match the performance of an index while active ones look to beat the index’s performance.
- Expense ratio: It is important to consider the expense ratios of ETFs before investing in them. Higher expense ratios may eat into the capital gains and lead to no gains. Therefore, if all else is equal, an ETF with a lower expense ratio will help to make more money.
- Build the portfolio based on your investment goals: Another key to success in ETF investing is proper planning. Investors must take a look at their investment goals, time horizon, and risk tolerance before picking the suitable ETFs for them.
As a bottom line, alternative investments are excellent avenues for diversification; however, they are subject to a variety of downsides, including illiquidity, lack of regulation, and high initial capital requirements. For those who are not familiar with investments, ETF investing is still considered alternative but marries the positives of traditional investing with those of alternative solutions.