Alternative asset classes typically include private equity, hedge funds and commodities. These asset classes are growing in importance as they provide diversification benefits away from the traditional asset classes of equities and bonds.
Whilst it is unlikely that an investor would wish to invest solely in one of these asset classes, they are playing an increasingly important role as part of a balanced investment approach.
Private equity is medium to long-term finance provided in return for an equity stake in a potentially high-growth, unquoted company (i.e. not listed on a stock exchange). Typically these are companies in the early stages of their life, who may have trouble raising appropriate financing as well as more established companies that may be undertaking a management buy out.
The most common way to invest in private equity is through pooled funds. These are managed by specialists in private equity investment and invest directly in the shares of private companies.
It is also possible to invest in a private equity fund of funds. These are funds that invest in a number of private equity funds, which in turn invest directly in the shares of private companies. By spreading the capital more widely they reduce the risk arising from investing in an individual fund.
If you can take a long-term view (say more than 10 years) on a portion of your assets, then private equity may offer a good opportunity to diversify your overall investments and achieve positive performance returns.
There is no clear rule as to what constitutes a hedge fund. It is a term that is used to describe any number of different investment strategies. These strategies often involve the use of financial derivative instruments like futures and options.
As a general rule a hedge fund is a pooled investment vehicle that is privately organised and administered by investment management professionals and is not widely available to the public. They are typically unconstrained by legal limitations on their investment discretion, and can adopt a variety of different trading strategies.
Many of these funds share a number of characteristics:
- They can hold short positions (borrowing a security from a broker and selling it, with the understanding that it must later be bought back)
- Employ leverage (debt) to enhance returns
- Pay a performance or incentive fee to their hedge fund managers
- Have high minimum investment requirements
- Target absolute returns (rather than returns relative to a given benchmark, such as a stockmarket index).
A commodity is any bulk good that is traded on an exchange; and is a physical substance.
Examples of commodities that can be invested in include coffee, orange juice, cocoa and soya beans, as well as oil, gas and many metals - for example gold, aluminium and platinum. Commodities are typically bought and sold on futures markets where producers combine with manufacturers and investors to form a market.
The main attraction of investing in commodities is that, in the long run, their performance has little correlation with stock and bond markets so that they offer a clear diversifier from these asset classes. They also exhibit low correlations against other diversifying assets such as private equity and property.
Historically, commodities have also provided protection against rising inflation as the intrinsic value of these goods themselves rises in an inflationary environment. The recent interest in commodities as an investment class has been driven by rising demand for energy and raw materials - often those exported from the emerging economies of India, China and Brazil - as production and consumption of goods has increased as a result of strengthening economic growth around the world.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested