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Alternative Investments: – How to Help With Portfolio Diversification

Muskan Agrawal

| Updated: Nov 07, 2022 | Category: AIF Registration

Alternative Investments: - How to Help With Portfolio Diversification

In today’s era, investments are very important for the future. Long-term and short-term investments are essential to secure your future financially and create your portfolio. Moreover, only one or two long-term time horizon investments will not give the healthy returns that people are hoping for when they retire.

That’s why everyone needs portfolio diversification with alternative assets. Better returns, more tax savings, and reduced risk are offered in the diversified portfolio. There are different ways to diversify the portfolio. Investing in stocks, mutual funds and ETFs can reduce your exposure to company-specific downturns but may leave you vulnerable to sector-wide losses.

When a person chooses the best alternative investments to help diversify their portfolio, they are helping to protect their assets while entering different markets. Here’s what everyone should know about why it is essential, portfolio diversification strategies, factors to consider, and new opportunities for investment within the sphere of alternatives.

What Is Alternative Investments?

It is also known as an alternative asset. Alternative investments are any investments besides stocks, bonds, and cash. Alternatives assets are not easily converted into cash. They may also offer tax benefits that are not available in traditional investments. 

The most Familiar types of alternative investments include:

  • Hedge fund
  • Private Equity
  • Real estate
  • Debt investing
  • Commodities

Why Diversification is Essential

Portfolio diversification is a must in any economy. In a bull market, diversification is beneficial to gain profits across various sectors, which can build significant value. During volatility in the market, a diversified portfolio can help mitigate the risk. And depending on the investing target, a balanced portfolio can even help gain secure returns over a certain period.

If people are ordinary investors or don’t know about other alternative investments, then most of your portfolio likely consists of stocks. Stock holdings tend to be considered risky in one’s broader portfolio. When markets are in the Bull Run, having direct stock ownership means you win the race. But in other cases, people probably face losses when the market is down or in the bear run. Their return is on the opposing side, unlike investment funds, which often reallocate their underlying investments to mitigate these losses.

Therefore, it’s tough to balance the exposure to the market through other means, such as investment funds, bonds, and alternative investments.

In today’s era, investing only in stocks is precarious; we all see where the market is. It impacts the whole economy, with many investors bearing losses due to the sudden outbreak of the market. This means that a well-balanced portfolio doesn’t just help you avoid losses and risk; it can also drive value you may not have otherwise.

Strategies for Portfolio Diversification

Following are some strategies for portfolio diversification:-

Individual Asset Diversification strategy

In this, invest in an asset array within a similar asset class. Investing in this is as simple as buying the market index to ensure a diversity of high-risk stocks and low-risk stocks over industries evenly standoff in the portfolio. It also means deliberately investing in industries that seem to complement each other. 

International Market Diversification strategy

The second strategy is to look international market[1]. If a domestic country’s economy performs badly, then to reduce the risk and balance your portfolio, investing in international markets will be helpful. But follow the rules and regulations of other countries because other countries may have different rules, regulations, and investing processes than others.

Asset Class Diversification strategy

The last strategy is to diversify the portfolio by investing in asset classes. The inclusion of traditional investments which drive in the public market, such as bonds, stocks, and cash and alternative investments primarily run in the private market and are mainly uncontrollable.

Alternative investments are highly complementary to traditional investments, making them an excellent addition to the portfolio.

Factors to Consider for Diversified Portfolios

The alternative investment asset class has various types of assets, each with a unique trait. How do people know which is the best fit for their portfolio? Several components can help investors or ordinary people to decide. Compare each alternative asset type to the portfolio’s traditional investment types to ensure diversification.

Time Horizon & Liquidity

The time horizon or planning horizon is the fixed time an investor can expect to hold a particular investment. Planning horizons are significant and it is ranging from a few hours to a few years. Liquidity depends upon the time horizon. An investment with a long holding time is considered as a non-liquid until it reaches maturity.

Traditional investments have no fixed time and are easily converted into cash. Investors can liquefy their investments whenever they need.

Alternative assets are non-liquid investments with much longer planning or time horizons. For some alternative investments, time is fixed at signing a contract, in the case of a private equity firm where the partner is limited. Another area for long-time horizons is because they’re hard to sell or require a long time to accumulate value. Here are a few examples:

  • Hedge funds: The time horizon is very short to moderately long (a few years) and they invest in various asset classes.
  • Private equity: The time horizon of Private equity’s typically around ten years.
  • Real estate: Real estate investments held by Institutional investors or a company for eight years on average. There is no specific time horizon for individual real estate. Still, moving a real estate asset quickly cannot be easy, depending on how the market performs.
  • Commodities and Collectibles: Commodities and collectables have long, flexible time horizons, requiring time to accrue value. 

Industries & Markets

Choose investments from different industries and markets to diversify the portfolio for better results. Before investing in any private equity or debt fund, analyse industry and market trends for the private companies you’re considering and choose those specific companies in a particular industry with a high level of complementarity. When investing in real estate, spread the money between different types or geographic regions.

Potential Threats and Risks 

Mitigating the risk is one reason for diversification, and alternative investments or assets provide various risk levels. Moving back to the conception of time horizons, investments with more extended or fixed periods are less risky because the market has sufficient time to correct itself from the downturn. Nevertheless, suppose a person invests in a physical asset such as a building, land, natural resource, or collectable. In that case, we have more time for the asset to be vandalised, stolen, or lost, adding additional risk.

Consider the types of risk and levels of risk in the portfolio and select investments that complement them.

Common Diversification Pitfalls

The ordinary investor knows that diversification is essential and has likely considered ways to diversify. 

Stock Diversification

Investment in stocks is more volatile than other in investment types, minimising the margin for error. Stock diversification is often mistaken for buying a ton of different stocks. This is far from the case, however. One’s study found that investments in well-performing stocks provide more returns than tons of variety of stocks.

Experts say many investors invest and hold not more than 30 stocks in their portfolio. For diversification, adding stocks to the portfolio not means a higher return. Diversify the portfolio with top-tier stocks, which gives a higher return than the tons of non-performing stocks. In this perspective, diversification only adds bulk to your portfolio rather than value or safety.

Fund Diversification

A wide range of investment funds increased the market today, the same as stocks. Moreover, other than stocks, investors may use other alternative investment for investment in many overlapping funds. This means investors retain the same underlying properties over multiple funds. The invested in funds that overlap with each other will steal the returns over the long term.

Bond Diversification

In the diversification of holdings, people or investors also invest in bonds as they give a guaranteed interest rate over a specific period. Now, carefully remember that the money invested in a bond and the issuer responsible for issuing it are among the safest investments. These are the common alternative asset for investment, or we can say that this is the small part of the more significant problem that remains hidden. People have other options for investment, which will help them get constant and healthy returns compared to these common alternative investments.

Alternative Investment Opportunities for Diversification

People must avoid scams and get-rich-quick schemes when thinking about alternative options to put their money. Instead, focus on well-founded investment vehicles that may help them prosper. Here are some new types of recognised alternative investments people can also consider.

Peer-to-Peer Lending

Peer-to-peer lending, also called P2P lending, is a relatively new alternative investments option. Online Peer-to-peer lending services provide loans for companies, personal loans, and other things also. If a person joins a group of investors willing to provide a loan to other people who need money, then the loan will be provided by you after the borrower qualifies.

There are many P2P lending companies. There are other institutions or banks involved in this investment option. The two or more investors’ money is pooled together and then provided as a loan to the needed individual. 

Gold and Precious Metals

Gold is widely known as a natural inflation hedge, a liquid asset, and a long-term value. As a result, it is often in demand and will become a strong competitor to equity investment.

Gold is an excellent diversification asset due to its low correlation with other investment classes, especially stocks.

There are various ways for investors or individuals to get gold, such as purchasing and holding physical gold such as bars, gold exchange-traded funds (ETFs), and gold accounts, or can indirectly invest through futures and options or gold mining stocks.

Agricultural Commodities

Commodities are another standard option for alternative investors seeking to branch out of the stock market for diversification. Agricultural commodities are vital elements of the economy as well as society itself. Because commodities are so important, they provide an excellent alternative investments opportunity. Prices tend to stay consistent so long as supply and demand are balanced. When inflation strikes, agricultural prices tend to increase. This provides an excellent hedge against stock market losses.

Real Estate

Investment in real estate means buying and owning property, land, or building. The individual can buy a home, apartment, or multi-family dwelling. 

People can hire a property management company to handle the responsibilities that come with property ownership. Of course, It will cost money, but it will be beneficial in the long run. Another way is to use an online investment platform focusing on real estate.

Owning a Business

An investor can use their own money to invest in the business, which has the potential to earn the highest returns and profits of all your investment alternatives. Another way is to put some money into a business, and the rest will invest elsewhere. 

Equity Crowdfunding

Another way to invest money for diversification is to invest in other companies. Startup companies or small companies that need funds can give shares of their companies on equity crowdfunding websites. 

If a person invests through an equity crowdfunding site, they own part of it and will be rewarded if it is successful. But, in this, people risk losing part or all money they invested in if the company does not succeed. Individuals can start investing their money in equity crowdfunding with a small amount.

The investment portfolio should be diversified. This means you should consider various stocks, but you can also invest in non-stock options. Always keep that in mind where the money invested will have a maximum chance to grow, but the risk is also the same as the return.

Evaluation of the Value of Alternative Investments in Diversification

If assets are primarily tie-up to the market, people may not increase their diversification options. Alternative investments come into the picture. 

With the help of alternative investments or assets, it is possible to invest in asset classes that are high in value, and market moves don’t affect them. This is called “low correlation”. Low- correlation means that these alternative assets don’t need to increase or decrease their valuation under stocks. By holding several low-correlation investments, investors can preserve value even if their stocks begin to fall. Simply put, alternative investments help buck market trends. While some these investments concentrate on steadiness and stable growth over a long period, others allow investors to take on greater risk than returns that exceed market averages. Regardless of what your threshold for risk might amount to, a wide range of investments are there to help investors diversify their assets in a wiser term.

Conclusion

Alternative investments are critical for building robust and diversified investment portfolios. These investments are the best options to make healthy returns in future. Strategies help diversify the portfolio but that takes time to understand portfolio diversification through alternative investments, including liquidity, industry, risk level, and market trends. This knowledge will help everyone choose better alternative that mitigate the portfolio’s overall risk while increasing the returns.

Read Our Article: Alternative Investment funds and its Disclosure Standards

Muskan Agrawal

Muskan has completed a Bachelor of Commerce and MBA with a specialisation in Finance and Marketing. She is very dedicated, focused and attentive towards her work. She has a decent knowledge of Finance and Accounts with a prior experience in the finance domain. She secures experience in research work which enhances her knowledge and skills.

Business Plan Consultant


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