Question

Why Hedge Funds, Private Equity, Venture Capital, Infrastructure funds, Commodity funds and Real Estate referred to as Alternative investments? Your answer must include

(i) valuations difficulties

and

(ii) diversification benefits.

Answer 1

An alternative investment is a financial asset that does not fall into one of the conventional investment categories. Conventional categories include stocks, bonds, and cash. Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk.

Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.

Pros

• Counterweight to conventional assets

• Portfolio diversification

• Inflation hedge

• High rewards

Cons

• Difficult to value

• Illiquid

• Unregulated

• High-risk

Valuation Difficulties

Because many real estate and private equity transactions are non-public in nature, it is difficult to collect the data and track the “last” market price. Some assets (e.g. real estate or infrastructure projects) are so unique that it is impossible to find other assets and other transactions which would be similar enough to be used as reference in valuation.

Diversification Benefits

Because alternatives tend to behave differently than typical stock and bond investments, adding them to a portfolio may provide broader diversification, enhance returns and increase income levels. With low correlation to traditional asset classes, alternatives can be a beneficial way to diversify your portfolio.