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Alternative Investments: Why are they Important?

Updated: Jun 30, 2021

People generally think of conventional assets like stocks, bonds, and cash when they think about investing. This kind of investment is the usual for most individual investors, whether it's an index fund in your 401(k) or cash in your savings. However, this forms just one aspect of a diverse portfolio.

Creating sustainable wealth necessitates a well-diversified portfolio. Diversification lowers overall portfolio volatility, reduces losses from market shocks, and increases returns over the medium to long term.

Investing in a range of stocks, bonds, and other publicly traded items may diversify a portfolio. Alternative investments, on the other hand, can provide even greater diversity. There are numerous advantages to diversifying your assets beyond common equities and bonds. Let's get right to work.

What are Alternative Investments?

Alternative investments, often known as "alternatives," are investments that are not made in stocks, bonds, or cash. Instead, the phrase encompasses various assets, from private equity and hedge funds to gold, real estate, and farms – even a rare wine or stamp collection.

Alternative investments can be private or public. REITs, or real estate investment trusts, are an alternative investment you've probably heard of. This is a typical alternative investment for the average person. You may have heard about REITs from your financial adviser, and you may even have some REIT assets.

While REITs can be an excellent investment, they lack many of the benefits of private alternative investments. A lot of investors aren't aware of the difference. Private real estate funds, on average, outperform REITs substantially. We've discovered that the most significant gap in most investors' portfolios is in private alternative investments, so that's where we'll focus.

Hedge funds, venture capital, oil and gas, private equity, and real estate are popular alternative investments. Some people include jewels and precious metals, art and antiques, and collectibles in their definition.

Here is some detail about these forms of alternatives

Hedge Funds

These funds can invest in a wide range of securities, although they are often restricted to publicly listed equities. There are many strategies, but the objective is typically to create returns in both up and down markets using their unique method.

Venture Capital

Venture capital firms specialize in investing in privately-held businesses. These businesses are often in the early stages of development or are just getting started to rapidly expand and eventually seek an exit through purchase or an IPO (IPO).

Private Equity

Private equity is the widest of the three categories, as it encompasses all private investments other than venture capital. Fund managers in this category can handle anything from modest million-dollar funds to multibillion-dollar funds. They invest in various assets, including real estate, infrastructure, oil and gas, and debt. Another essential subgroup of private equity is that which tries to acquire controlling shares in running companies.

Importance of Alternative Investments


One of the most important advantages of alternative investing is portfolio diversity. Alternative asset returns and other performance indicators usually have minimal correlations with traditional asset classes like stocks and bonds. As a result, alternative investments can reduce volatility without compromising return. This attribute makes them a valuable risk management strategy for reducing an investment portfolio's risk. While all investments carry some risk, adding low- or no-correlation assets to other portfolio allocations can help to decrease portfolio concentration, minimize volatility, and generate higher risk-adjusted returns.

Inflation protection

Alternatives can also be an effective inflation hedge if their returns are connected with inflation. As inflation rises, these assets' returns tend to climb as well. As a result, the investment is thought to defend against a currency's diminished buying power caused by a loss of value owing to rising costs. In other words, inflation hedging can aid in the preservation of an investment's value. Although some assets appear to offer a good return, they might be sold at a loss when inflation is considered. Infrastructure and commodities are examples of inflation-hedging investments.

Tax Benefits

Alternative investments might potentially offer significant tax advantages. Because of the structure of many alternative investments, you get to keep more of your profit. You partly own the fund or syndication in many private alternative investments, and accompanying tax benefits are transferred to you directly.

Pass-through depreciation and long-term capital gains treatment are the two significant tax benefits. In addition, depreciation expenditure is deducted from net income by many real estate funds or syndications, lowering taxable income. Therefore, depreciation/depletion tax treatment for oil and gas assets is highly advantageous.

Investors are also unaware that qualifying retirement funds, such as a 401K or an IRA, can be used to invest in private alternatives. As a result, you may grow your investment tax-deferred or even tax-free depending on how you organize it.

Opportunity for a higher return

Alternative investment allocations are also attractive to pension funds, endowments, foundations, and other institutional investors. His goal is based on the idea that certain alternative investments have higher risk profiles on their own but might provide better returns by accepting that risk. A good example is venture capital investing. While seed and early-stage investments carry a higher risk of investment loss, they can also reward investors handsomely with significantly higher returns. This superior risk/higher reward profile may be seen in a variety of hedge fund strategies.

Unique possibilities and exposures

Traditional stock and bond investment, as previously said, may provide investors with the opportunity for both growth and income. But, on the other hand, equities and fixed income allocations do not give access to new or unusual exposures. That's where alternative investments may pay off handsomely, allowing investors to invest in real estate, infrastructure, start-up companies, and a variety of other assets that complement standard portfolios.

In Summary

Alternate investments can be used as a diversifier, an inflation hedge, a volatility dampener, and a way to access alternative growth and income exposures. Alternative investments, which are more widely available than ever before, are your ticket to investing like the institutions.

Disclaimer: Oasis is not a registered broker-dealer, investment adviser or investment manager. Oasis does not provide tax, legal or investment advice. You should consult your own tax, legal and investment advisors before engaging transactions.


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