In the world of sports, the weightlifter will assess the weight to be lifted vis-à-vis his capacity and strength; a diver will measure the depth and nature of water before taking the plunge. This analogy can be extended to the field of investment also. Every investor has to make an assessment as to the risks he will shoulder while making an investment. The individual’s propensity to take risks will define the class of investment which he would prefer to invest in. What are alternative investments?
Other than the conventional forms of investments like bonds and shares, investors may often explore non-conventional areas for investment, like structured investment product, venture capital, equity crowd funding, rare coins, stamps, forestry and art. All these options are generically termed as ‘alternative investments’. Structured investment products:
Among the different alternative investments, structured investment products are more popular in India. Structured products are mostly market linked. These products are pre-packaged with well defined investment strategies. The manufacturers of these products pre-package and structure the product based on derivatives, stock index, foreign currencies, debt instruments and such other underlying. Some structured products offer capital protection, of course with some caveats. Why do investors consider alternative investments?
•Investors may find that the returns from conventional modes not yielding the expected returns and could hence venture into the world of alternative investments. Investors expect that the alternative investments will give better risk-adjusted returns than the conventional assets such as equity.
•Some investors consider alternative investments because they get bored with regular equity investments. They need variety.
•Some investors consider alternative investments because they enjoy the thrill it gives.
Do you think the above reasons sound reasonable? They may not. Risk involved in alternative investments:
It is alright to take a detour, and test the water of alternative investment; however, the investor has to get a measure of the depth of the water in the pool. It is important to make an objective assessment as to the risks associated with the particular investment type and what could be the expected prospect of returns from the investment type.
Here we analyze the various risk forms of alternative investment so that investors can make a knowledgeable judgment on the same.
Let us look into the specific nature of risks associated with alternative investments:1.Alternative investments are less researched
Alternative investments are less researched in comparison to conventional investments and this makes it difficult for an investor to make informed judgements.Lack of adequate information and knowledge can be a road block in the proper assessment of the associated risks.
Operational and organizational risk analyses are a pre-condition to risk management, however lack of knowledge impedes such an analysis. It is possible that while investing in a tree within a plantation, the investor might be unaware of the soil characteristics and the environmental issues around the plantation. This would make it difficult to make an objective assessment of the risks involved in such an investment.2.Alternative investments are illiquid:
More often than not it is difficult to sell alternative investments when one is looking to raise some cash. For example it would be difficult to find a buyer overnight for alternative investments like rare coins or stamps. Also structured products are not frequently traded on exchanges the way stocks do.
One must be prepared to hold on to such investments for long period of time and do not count on them in situations of stress as a means to raise cash.3.No proper price discovery mechanism for alternative investments:
Since the options for alternative investment are unconventional, the methodology of their valuation is not easy and transparent. While bonds and shares follow a clear valuation norm there is ambiguity in valuation of alternative investments like a piece of art or property in a foreign country. However, market linked alternative investments are comparatively not difficult to value. To add to the caution, though they can be valued efficiently, they may not be sold at the fair price as there is no ready market for them.4.Alternative investments and volatility:
Alternative investments based on debt instruments are also less volatile. Structured products issued with capital protection capital may offer some solace to the buyer.
However, aggressive alternative investments are more volatile and could behave in an unpredictable manner. This could lead investors to lose money without hope for recovery in the long run. The investor is unaware as to how the market could evolve in the future. Being unconventional in nature, the alternative investment option could turn out to be erratic and could lead the liquidity aspect of investment to be affected. 5.Alternative investments and scams:
Gullible investors may be conned by people involved in scams by projecting quick and high returns through the alternative investments route. Since there is not much information available, there is a possibility of ‘ponzi scheme’ being sold as an alternate investment to naïve investors.Should you go for them:
Just because, you want more returns, alternative investments are not likely to give better returns than well managed equity funds. Successful investment needs discipline and patience. If you want variety and thrill you can go to movies or casinos. Avoid investing in alternative investments blindly. The author is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company