Alternative Investments – The Pros and Cons
This three-part series will cover all you need to know about alternative investments. Click below to read the previous articles in this series.
- Part One – Alternative Investments – What are My Options?
- Part Two – Why Alternative Investments?
- Part Three – Alternative Investments – The Pros and Cons
Like any investment, alternative investments come with their own set of benefits to the investor, as well as potential risks.
What are the benefits?
Low correlation with conventional asset classes
The value of alternative investments often change at different rates to conventional investments such as shares, direct property and bank deposits/bonds. This characteristic makes them ideal for portfolio diversification and risk seeking.
Alternative investments have the potential to provide greater returns than conventional investments. This is especially evident when comparing the two. For example, an annual NZX portfolio increase is often relatively small when compared to an investment in a private company, where, after a few years, the value of your shares may increase exponentially. In general, Angel Investors and Venture Capitalists look for a 5–10x return on their investment capital.
Ability to use your knowledge and experience
If you have knowledge or experience about a niche area or industry, you can benefit from that knowledge when investing in private companies. Such knowledge becomes an asset and competitive advantage as it will not be publicly available to everyone. Investors in private companies often lend a hand at a governance or managerial level using that experience for the benefit of the business as a whole.
What’s the catch?
High minimum investment
Alternative investments usually come with high purchasing costs. Funds may require a minimum investment amount. Learning about fine art or wine takes time and effort and good quality is often beyond the reach of most people.
Alternative investments have low liquidity, especially when compared to conventional investments. Low liquidity means that it can be harder to sell something because there is no market or not many people willing to buy it. For example, it would be much harder to sell shares in a private company in the next hour, compared to selling shares of a publicly listed company such as Briscoes. This is often because information is not widely available for the company in question. Therefore, it is harder for potential investors to make fully informed decisions. There may also be restrictions surrounding the ability to exit the investment. For example, shareholders agreements may only allow an investor to offer their shares to other existing shareholders first and then wait for a process to be completed by the board.
Valuation is difficult
It can be hard to ascertain the value of a start-up company. Often specific knowledge, skill and expertise is required to value such items. Furthermore, demand for such investments is also hard to predict, especially as information is not widely available so not many people know such investment options exist.
If you want to find out more about investing in alternative investments, please get in touch!