Alternative Investment - Explained
What is an Alternative Investment?
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Table of ContentsWhat is an Alternative Investment?How Does an Alternative Investment Work?Alternative Investments for Diversification and HedgingAlternative Investment Costs and Tax ConsiderationsAccessing Alternative Investments Through ETFsRegulation of Alternative InvestmentsAcademics Research on Alternative Investment
What is an Alternative Investment?
An alternative investment refers to an investment that invests in assets order than the traditional asset classes. This fund or investment goes beyond traditional methods and assets when investing. Examples of alternative investments are hedge funds, venture capital, private equity, real estate investment trusts, managed futures, derivatives contracts, commodities, and others. Alternative investments invest in assets beyond the traditional stocks, bonds, gold, timber, and cash. Alternative investments are often held by institutional and accredited investors who have a high net-worth. Given that alternative investments are capital-intensive, and are complex in nature, individual investors might not be able to handle them.
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How Does an Alternative Investment Work?
Unlike other traditional investments that are highly regulated, alternative investments have limited or no regulations which mean any investor that invests in them must be ready to take all the risks involved. Due to the lack of regulation of alternative investments, they are exposed to investment scams and fraud. Investments of this nature also have high free structures different from traditional investments. Alternative investments are also less liquid when compared to conventional assets like stock and bonds. Furthermore, alternative investment transactions are complex and unique, it, therefore, it becomes difficult to know the actual value of these investments.
Alternative Investments for Diversification and Hedging
It is important to know that alternative investments have traits different from conventional assets. The uniqueness of these investments makes them suitable for the purpose of diversification. Alternative investments are often handled by institutional investors given that they require large funds and adequate monitoring. As a good way of achieving portfolio diversification, many institutional funds have begun to separate a percentage of their portfolio to accommodate alternative investments. Investors who invest in these investments must, however, perform due diligence in order not to fall victim to investment fraud.
Alternative Investment Costs and Tax Considerations
There are certain tax benefits that alternative investments offer when they are held over a long period, investors are required to pay lower capital gains and lower tax as against conventional or short-term investments. Aside from tax benefits, alternative investments have lower transaction costs, however, investors are required to pay a high upfront fee at the initial stage.
Accessing Alternative Investments Through ETFs
Alternative investments are typically designed for institutional investors or investment firms. Individual or retail investors invest in conventional assets most times such as stock, bond, real estate, gold, and precious metals. However, there are specific ways retail investors access alternative investment, this is through ETFs in which these investors can access different categories of investment.
Regulation of Alternative Investments
There is limited regulation on alternative investments, the legal position of regulatory bodies when it comes to alternative investment is quite unclear. Increasingly, alternative investments are subject to the regulation of the DoddFrank Wall Street Reform and Consumer Protection Act. Despite this regulation, they operate at laxity as compared to traditional investments. For instance, the Securities and Exchange Commission (SEC) and the Financial Services Regulatory Commission oversee mutual funds and ETFs, but in the case of alternative investment, there is an absence of strict regulation.