Describe about the “Alternative Investment Classes and their Role in Investment Portfolios” with examples, a selection of seven (7) alternative investments which are generally available on capital and other markets, the expected / realized returns and risks of each, and to consider how they are used in constructing and hedging investment portfolios.
In the present scenario investment management plays an important role in the entire economy, investment management is the professional management of different securities such as bonds, shares and other securities or other assets. The main aim of the investment management is to protect the interest of the investors (Bhala et al 2016).
Alternative investment provides a wider investment opportunity for the investors, which includes private equity, venture capital, real assets, mutual fund, hedge fund, private placement debt, direct investments, etc. Every investor invests in different ventures to gain profits, but there also involves risk in such investments function by maintaining low correlation with the bonds and stocks, which makes them difficult to be valued and in compared to the traditional investments alternative investments are more liquid (TheStreet 2015).
The main aim of this assignment is to highlight the different alternative investments which are available on capital and other markets. This assignment will also highlight the expected returns and risk associated with such investments and also studies how they are used in constructing and hedging investment portfolios.
(a) Private equity:
In the present scenario, there are more numbers of private organisations than the public organisations and most of these private firm functions with the capital of the investors. Private equity is a wider concept that encircles the whole investment cycle of the private money markets, and various private equity business specialised in different investment strategies. Private equity organisations collect funds and take financial support from both institutional and non-institutional investors. Then the fund is used to invest in new up-coming private firms (Harris et al 2014).
Private equity is also known as the equity securities that are not traded publicly. Private equity funds, which are expert in private equity investment has made this class of assets assessable for the different market participants and the institutional investors. This asset class has witnessed a rapid growth due to the early successes of some big private equity funds. Private equity includes investments in venture capital, start-ups and provides financial support to a firm during its growth phase. One example of private equity firm is Blackstone group, which is the world’s largest private equity organisation (Harris et al 2014).
In the case of private equity, the expected return is high, so that higher risk associated with private equity can be compensated. The higher value of Beta which is inherent in most of the private equity investments gives rise to extra return and extra risk (Caselli et al 2013).
Private equity investments are used to minimise the risk in the investment portfolios.
(b)Venture capital:
The investment of capital in the promising companies and start-ups is known as venture capital investments. The investor or the venture capitalist in return for the investment made in the firm gets the ownership interest. There are many examples of firms that have many investments which are made by different venture capitalists. Facebook, Google, Intel, Apple, Compaq are few such firms (Lerner et al 2012).
The venture capitalist by investing in the company is allowed to be closely related to the functioning of the firm. The capitalist can also provide assistance and ideas with planning and can also receive calls during the meeting. The venture capitalist not only invests money but also invest their time and skills in the company (TheStreet 2015).
But at the end of the day, the core objective of the venture capital investment is to earn a profit by investing capital in the upcoming companies that have potential to grow and earns a profit for them (TheStreet 2015).
The risk and expected return associated with investment in such companies are high because these investments are capitals that are invested in the firms that have a high component of risk related to them. These risks are related to cash flows, benefits, etc. usually, the venture capitalist invest in equity or shares which generate higher return because the risk associated with such investment is higher (Korteweg et al 2013).
Venture capital investments are used to minimise risk in investment portfolios.
(c)Real assets investments:
The tangible or physical assets that have elemental value, they include oil, real estate, agricultural land and precious metal. Goods such as luxury and collectable goods also come under this category. Jewellery, art, rare coins wine and baseball cards are also included under this category. An investor can directly buy real assets or they can invest in a fund that is specialised in real assets (Campello et al 2013).
Investors can potentially broaden their portfolio diversification; can also increase the possibility to attain a constant return that goes together with the inflation and also increase the possible long-term returns with the help of global trend.
In the recent years the demand for real assets have increased considerably but for all investors, it is not considered suitable. The risk involved in real assets investments is unique, for example, the company that are related to infrastructure are more volatile to government regulations, adverse economic, declining the value of real estate, financial instability, etc. There is no doubt that there involves a certain amount of risk in every investment. The real assets do not grow with constant rate and they may also witness negative growth (Campello et al 2013).
Real assets help the investor to widen his portfolio diversification and also help them increase the possibility to attain a constant return that goes together with the inflation and also increase the possible long-term returns with the help of global trend.
(d)Hedge fund investments:
Hedge funds collect capital from investors and invest them in securities and different types of investments with the aim to earn positive returns. Hedge funds are not supervised strictly as in the case of mutual funds and are more lenient than the mutual fund investments to undertake investment. Hedge fund investments are not suitable for all the investors because investment in hedge fund involves high fees and a greater risk of loss. The managers of the hedge fund raise capital and invest them in different financial instruments and different styles (Investor.gov 2016).
The risk associated with hedge fund investments is higher because the hedge fund investments are not regulated strictly, so it exposes the investor to a greater risk of loss of investment. And all the investors invest in hedge funds with a motive to earn greater returns. Hedge funds are suitable for wealthier investors because the risk and the fee of hedge fund investment are higher (Bali et al 2014).
(e)Mutual fund investments:
Whenever an investor decides to invest, he comes across different investment options, which may include bonds, stocks, shares and money market securities and every investment options has its set of advantages and disadvantages. In the case of mutual fund investments, it gives the investor the opportunity to pool their capital and invest them in complex securities, which are managed by a fund manager. A mutual fund also offers creative products such as exchange-traded funds, funds of funds, Fixed Maturity Plans, etc. Investors get many benefits from a mutual fund; the benefits may be financial profit or convenience (The Times of India 2016).
An investor can achieve greater inflation-adjusted returns with the help of mutual fund investments and they do not need to invest a lot of time and energy in it. The investors who are more inclined towards saving time and convenience should go for mutual fund investments. Mutual fund investments also offer its investor with low investment cost in comparison with direct investment in money markets. It also provides an excellent opportunity for investment to the investors with low investment capital.
The returns generated from mutual funds are higher because it provides the investor with a wide range of companies and sectors to invest.
(f)Private placement debt:
Investment of capital in debt is also a great market. Just like the equity private placement debt investments are not mad available to public for trading purpose and they are also not rated by the rating agency. The private firms are financed with the help of mezzanine debt and promissory note, which provides the investors with a constant flow of cash (The Times of India, 2016).
Only a few investors have the access to private placement bonds because these bonds are not registered and are offered privately. De Nederlandse is the largest investor in private bonds in Netherlands. In private bonds, the access to the primary market is restricted because of the nature of the private placement market. The cost offered by the private placement debt is lower liquid than the other investments. The private bonds are best for the medium to long term investment because private bonds are not traded publicly and have lower liquidity. They are also considered as buy-and –hold investments.
No doubt that private bond is less liquid but they compensate these by generating higher returns and also help the investor in widening their diversification.
(g)Direct investment:
Direct investments are the type of investments, where the investors directly invest in private companies and start-ups. These investments are also known as angel investing, the main aim of the investor is to earn a profit. They invest in the firms that have a high potential for growth and the returns generated from such investments are high. But there also involves greater risk. Private companies will find investors with the help of private placement which is based on some assured valuation. The investors of the retail can also contribute to this by exempting the registration for the private companies because they highly depend on the registration. The company keeps looking for investment throughout their entire life cycle. So the private companies look for the companies that are already well established (TheStreet 2015).
The risk associated with such investment is higher because many start-ups end up shutting down their business. And direct investment also generates higher returns as the risk involved in such investment is higher.
Direct investment helps the investor to diversify his investment portfolio and minimise the risk of investment.
Conclusion
So the above discussion clearly highlights seven alternative investments which are available on capital and other markets, and also highlights the expected/realised returns and risks of each, and also discuss how they are used in constructing and hedging investment portfolios.
References
Alquist, R., Mukherjee, R. and Tesar, L., 2014. Liquidity-driven foreign direct investment. Graduate Institute of International and Development Studies WP, (17).
Bali, T.G., Brown, S.J. and Caglayan, M.O., 2014. Macroeconomic risk and hedge fund returns. Journal of Financial Economics, 114(1), pp.1-19.
Baumol, W., Goldfeld, S.M., Gordon, L.A. and Koehn, F.M., 2012. The economics of mutual fund markets: Competition versus regulation (Vol. 7). Springer Science & Business Media.
Bhala, K.T., Yeh, W. and Bhala, R., 2016. International Investment Management: Theory, Ethics and Practice. Routledge.
Busse, J.A., Chordia, T., Jiang, L. and Tang, Y., 2016. Mutual Fund Transaction Costs.
Campello, M. and Giambona, E., 2013. Real assets and capital structure. Journal of Financial and Quantitative Analysis, 48(05), pp.1333-1370.
Caselli, S., Garcia-Appendini, E. and Ippolito, F., 2013. Contracts and returns in private equity investments. Journal of Financial Intermediation, 22(2), pp.201-217.
Harris, R.S., Jenkinson, T. and Kaplan, S.N., 2014. Private equity performance: What do we know?. The Journal of Finance, 69(5), pp.1851-1882.
Investor.gov. (2016). Hedge Funds | Investor.gov.
Korteweg, A. and Nagel, S., 2013. Risk-adjusting the returns to venture capital (No. w19347). National Bureau of Economic Research.
Lerner, J., Hardymon, F. and Leamon, A., 2012. Venture capital & private equity: A casebook.
Mathur, A. and Singh, K., 2013. Foreign direct investment, corruption and democracy. Applied Economics, 45(8), pp.991-1002.
The Times of India. (2016). Why Should You Invest in Mutual Funds?.
TheStreet. (2015). 7 Common Alternative Investments That All Investors Should Know.
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