Alternative Investments are concerned with those asset classes that exclude the conventional categories of stocks, bonds, and cash. Instead, the most common form of alternative investing includes Private Equity and Venture Capital, Hedge Funds, Commodities, and Real Estate. Most alternative investments are illiquid and require to be held for many years before realising your position.

Characteristics Of Alternative Investing

• Low correlation of returns with “traditional” investing i.e. equities
• Less regulation than “traditional” investing
• Higher fees (often performance-based and management fees associated with Private Equity and Hedge Funds)
• Illiquid (i.e. there are often “lockup” periods whereby you cannot realise your position for x amount of months/years)

There are many kinds of alternative investment strategies such as fine wines, cars and even stamps. In this article, we’ll look at the 4 most common alternative investment categories that have a substantial market, these include Private Equity, Hedge Funds, Commodities Markets and Real Estate.

PRIVATE EQUITY (PE)

Private Equity is an alternative investment strategy whereby a company, fund, or investor purchases an equity stake in a private company or participates in a buyout of a public company, usually with the goal of developing and improving the acquired company before selling their initial stake in the future (typically 5+ years after investing).

The equity capital provided in a private equity transaction is typically used to expand or develop a business by funding advancements in technology, providing capital to allow for acquisitions, hiring experienced personnel, or simply improving their balance sheet position. Over the long term, the Private Equity firm may then look to sell this on for a profit or keep a controlling interest in the company if it holds valuable assets. In short, it's like flipping houses, only you’re not flipping houses, but rather businesses. The firm may choose to keep the company or sell it on for a profit.

Advantages of Private Equity

• Access to finance and liquidity, potentially at more attractive rates and conditions versus a bank loan
• Access to experienced companies (PE firms who provide the capital) and their workforce who are usually experienced within PE and turnaround strategies
• Accelerate a company’s growth strategy by utilising the funds and experience of the PE company

Disadvantages of PE

• It may be challenging for the PE firm to sell their equity stake as they need to find a buyer in the private market (private equity is not in the public markets and so cannot easily buy or sell holdings)
• Extensive due diligence is required by the buying company before bidding for a share in the company

Venture Capital (VC) is a form of private equity in which the purchasing company injects their capital into another business, but the main differentiator is that VC usually involves a significant amount of risk with the company seeking capital typically being a new, start-up business. The rewards, however, can be enormous and in the UK there are actually schemes which have tax advantages called SEIS, EIS & VCT.