Private Equity, Alternative Investments, Funds
An alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds, and cash. … Alternative investments include Hedge Funds, Private Equity, Distressed Debt Assets.
BREAKING DOWN ‘Alternative Investment’
Many alternative investments have high minimum investments and fee structures compared to mutual funds and exchange-traded funds (ETFs). There is also less opportunity to publish verifiable performance data and advertise to potential investors. Most alternative assets have low liquidity compared to conventional assets. For example, investors are likely to find it considerably more difficult to sell an 80-year old bottle of wine compared to 1,000 shares of Apple, due to a limited number of buyers.
Investors may have difficulty valuing alternative investments due to transactions often being unique. For example, a seller of the extremely rare 1933 Double Eagle $20 gold coin may have difficulty determining its value, as there are only 13 known to exist as of 2016. Alternative investments are prone to investment scams and fraud due to their unregulated nature, therefore it is essential that investors conduct extensive due diligence.
Alternative Investments for Diversification and Hedging
Alternative investments typically have a low correlation with those of standard asset classes, which makes them suitable for portfolio diversification. Because of this, many large institutional funds such as pensions and private endowments have begun to allocate a small portion of their portfolios, typically less than 10%, to alternative investments such as hedge funds. Investments in hard assets such as gold and oil also provide an effective hedge against rising inflation, as they are negatively correlated with the performance of stocks and bonds.
Alternative Investment Costs and Tax Considerations
Although alternative assets may have high initial upfront investment fees, transaction costs are typically lower compared to conventional assets, due to lower levels of turnover. Alternative investments held over a long period of time may result in tax benefits, as investments held longer than 12 months are subject to a lower capital gains tax in comparison to shorter-term investments. Hedge Funds, Private Equity, Distressed Debt Assets
- Private Equity
Private equity is a broad term encompassing the entire investment spectrum of the private capital markets, and different private equity firms specialize in multiple investment strategies. Private equity firms typically raise funds and take capital from both non-institutional and institutional investors. The funds will then be used to place investments in promising private companies. The capital is returned to investors upon an exit event such as an IPO or acquisition after the firm takes its management and performance fee.
- Venture Capital
This is a subset of private equity specializing in the investment in early-stage to growth-stage companies. Firms will specialize in early-stage investing, raising funds from high net worth and institutional capital and deploying them to companies ranging in industry, geography, and funding stages. This capital source is very important for start-ups and early-stage companies that have no access to public financing as many lack extensive operational or revenue history. Venture capital is typically a risky asset class but can produce outsized returns upon a successful liquidity event.
- Hedge Funds
These are pooled investment funds that are created to invest in a variety of strategies and asset types. Hedge fund managers raise funds and invest in a variety of styles and financial instruments. Some of the more common hedge fund strategies include equity long-short, distressed assets, arbitrage, and macro-trends. Hedge funds differ from private equity and venture capital funds as they invest in public equities and generally have greater redemption frequencies and liquidity, meaning investors can get their money out more often. Hedge Funds, Private Equity, Distressed Debt Assets