Investing in Alternative Assets: A Comprehensive Guide

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Exploring Alternative Investment Exposure via ETFs

ETFs or exchangetraded funds are available to all investors, accredited and non-accredited. Alternative ETFs come in a multitude of varieties including merger, arbitrage, risk parity, crypto, metals, real estate, multi-asset, and commodity. You can purchase ETFs at traditional investment brokerage firms like Fidelity, Schwab, Vanguard, and E*TRADE. Many of the investing apps, like M1 Finance, Robinhood, Webull, and Public, also provide access to ETFs.

Sample alternative ETFs include:

• Return Stacked Bonds and Managed Futures ETF (RSBT)
• Timothy Plan Market Neutral ETF (TPMN)
• Noble Absolute Return ETF (NOPE)
• RPAR Risk Parity ETF (RPAR)
• ProShares Merger ETF (MRGR)
• Bitcoin Strategy ETf (BITO)
• iShares S&P GSCI Commodity-Indexed Trust (GSG)

Advantages of Alternative Investments

The promise of lower correlations with stocks and bonds is a major draw of alternative investing. Pension funds and institutional investors have included alternatives in their arsenal for years. Yet, lumping all alternatives into one group might be cavalier. Keep in mind that within the broad category, there are a range of investment types. Some alternatives, like commodities, can provide a hedge against price inflation and protect your capital as prices soar. Investments that are negatively correlated with stocks and bonds can bolster your financial assets when traditional investment values tumble. Certain alternative investments, like hedge funds and private real estate deals, provide the possibility of higher returns and lower correlations with traditional assets. 

If you are seeking diversification beyond traditional stocks and bonds, then alternatives open up an avenue with a possibility of higher overall returns and lower volatility. Today, all investors have access to alternatives, although some would argue that the best deals are reserved for high-net-worth accredited investors.  

Disadvantages of Alternative Investments

The promise of higher returns and reduced investment portfolio volatility is a possibility, not a certainty. Some private alternative investment vehicles are not SEC regulated, adding to their risk. Higher risk of loss accompanies the promise of higher returns. Some alternative investment founders lack the expertise and training that you’ll find in the managers of most highly regulated mutual and exchange traded funds. With alternative investing, you might encounter uncommon tax reporting, causing additional tax preparation headaches. 

Many alternative investments have long lock-up periods and are illiquid. That means you may not recoup your initial investment for a period of months or years. Some of the best deals are only open to accredited investors. Fees for alternative investments can also be excessive. While ETFs and mutual funds typically charge less than a 1% expense ratio, some private alternative offers levy high expense ratios and additional performance-based fees. Another disadvantage of alternative investments is lack of income. Unlike bonds and many stocks, commodities, precious metals, art, wine and other alts don’t offer any cash flow. 

Understanding Secondary Markets in Alternative Investing

To counteract lack of liquidity, many alternative investments offer secondary markets. Secondary markets are avenues to buy or resell an asset that was bought or sold during the original offer. Conversely, a primary market is the platform where you can buy a new offer. It might be a stock initial public offering (IPO) or a crowdfunding real estate platform where you buy a share of real property from the original owner. 

Most stocks and bonds are liquid and readily bought and sold through public exchanges, which are secondary markets. Several alternative investment platforms offer their own marketplaces or secondary markets, where sellers can locate interested buyers for less liquid investments. Before investing in any alternative asset, it’s useful to understand the liquidity of the product.  

Factors to Consider When Investing in Alternative Assets  

Defining Your Investment Objectives

Many advisors suggest giving your money a job. When investing, begin with a plan that includes:

• Goal for the money
• When you will need it
• How much risk can you accept

After defining your goals, timeline, and risk level, you’re ready to create an investment portfolio and decide whether to add alternative investments to your stock and bond holdings. If you seek the added diversification and return potential of alternatives, and can accept the risk and liquidity parameters, then you might add this asset class to your stock and bond investments. Typically, diversification principles suggest maintaining a smaller proportion of alternative investments within a diversified portfolio. 

 Assessing Liquidity in Alternative Investments

Only invest money in the financial markets that you don’t need within the next three to five years. This goes for alternatives, stocks and bonds. While stocks and bonds are liquid and can be rapidly sold, many alternative investments require a few months to many years before redemption.

When investing in alternatives, understand the liquidity options for the investment. Private investments for accredited, wealthier investors might require five- to six-figure minimums and lock-up periods up to 10 years. Before purchase, determine if there is a secondary market for the investment and whether you can accept the expected lock-up period. 

Establishing a Time Horizon for Your Investments

Understand your money’s job. Is it capital appreciation for the long term, cash flow and appreciation, or stable value and liquidity for short term goals? Any money that you will need for an upcoming vacation, down payment on a home next year, or for emergency cash probably shouldn’t be in an alternative asset. These types of investments are usually difficult to liquidate. 

After you’re clear on your financial goals and when you’ll need the money, you can decide if a particular alternative investment is right for you. Read the investment’s fine print and match your time horizon for the money with estimated lock-up periods for your alternative investments. In general, plan to own alternatives for the long term.

Strategies for Building a Diversified Portfolio 

Building a diversified portfolio begins with determining your goals, timeline, and risk tolerance. Your assessment of those factors will determine whether to create a conservative portfolio, if you’re less risk tolerant and have a shorter timeline, or a more aggressive investment mix, if you’re younger and can tolerate more price volatility within your investments. In general, conservative investment portfolios contain greater percentages of fixed income bonds and cash, and less allotment to riskier stocks. The opposite applies to more aggressive portfolios. 

Any investment portfolio might include a small allocation to alternatives, which will be included within the riskier portion. Generally, it’s recommended to maintain less than 10% of your liquid assets in the riskiest assets, like alternatives. Returns and portfolio volatility are inversely correlated with the level of risk within the portfolio. Higher risk portfolios might achieve higher returns, with greater volatility. Conversely, expect lower returns and volatility from more conservative portfolios.

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