Alternative Investments: What Are They and How to Get Started

Key Takeaways:

• 1. Alternative investments are assets that fall outside conventional categories of currencies, stocks, and bonds.
• 2. Features of alternative investments include portfolio diversification, higher returns at a higher risk, a lower correlation against public markets, predictable performance, and lower volatility.
• 3. Risks of alternative investments include a relative lack of regulation and transparency, higher minimum commitments, lower liquidity, and difficulty in valuation.

When most people think of investments, they think of stocks, bonds, currencies, and other traditional financial instruments. However, there is a world of alternative investments that can provide access to a wide range of unconventional securities such as commodities, real estate, art, private equity, private debt, and hedge funds. Singapore’s asset management sector’s most significant growth in the past few years has come from alternatives. In 2021, assets under management (AUM) rose by 30% to reach S$1.23 trillion (US$0.9 trillion), according to the Monetary Authority of Singapore (MAS). The AUM for traditional investments has only grown by 13%.

What Are Alternative Investments

Alternative investments fall outside conventional categories of currencies, stocks, and bonds. Common alternative investments examples include:

• Private equity: Capital invested in private, unlisted companies in exchange for ownership or equity.
• Private debt: Capital investment in private entities in the form of debt instead of equity.
• Hedge funds: Pooled capital from Accredited Investors and financial institutions invested in various assets and instruments like land, stocks, derivatives, and currencies.
• Real estate: Investment in residential, commercial, and industrial real estate in primary and secondary markets.
• Natural resources: Investment in the production, development, or enhancement of natural resources, including metals like gold and silver, agriculture, and energy.

Each alternative class has unique characteristics that suit different investors’ needs.

Features and Risks of Investing in Alternatives

Below is a summary of the pros and cons of alternative investments:

Reasons for Alternative Investments

1. Broader Portfolio Diversification

There is a large amount of heterogeneity in alternatives from commercial real estate to venture capital to global almond indices. This variety may help diversify your portfolio and manage correlation risks against popular public instruments.

2. Potentially Higher Returns

Generally, traditional assets are covered extensively by analysts from banks, brokerages, and advisors. This means market participants have comprehensive information and have used it to set the asset at the right price for the right risk.

Some alternatives, in contrast, may not be covered extensively, or even if so, the information may not be acted on widely. This may provide opportunities for arbitrage and entering a mispriced asset “earlier” than others before its correction. However, this carries extensive risk and requires deep subject matter research.

3. Lower Exposure to and Correlation with Public Markets

Many investors may be keen to look for ways to stabilise and predict their returns performance, especially considering recent volatility in the stock market. Alternative investments tend to correlate less with the stock market and uncontrollable factors like the geopolitical environment. This means they may provide stability during periods of volatility and downturns. Hard assets such as oil, gold, and real estate could also be good hedges against inflation, especially in the current inflationary environment.

Risks of Alternative Investments

While alternative investments can be a valuable way to diversify a portfolio, they also come with substantial risks.

1. Relative Lack of Regulation and Transparency

One of the primary risks of alternative assets are the lack of regulation and transparency. Unlike stocks and bonds, which are heavily regulated by agencies like the Securities and Exchange Commission (SEC) and the MAS, alternatives may not be subject to the same level of scrutiny.

Regulatory maturity also varies across alternative types. This makes it difficult to get accurate information about an investment and increases the chances of fraud or making a poor investment decision.

2. Higher Minimum Commitments

Other than the lack of transparency, alternative investments are often not structured with the average investor in mind. In many cases, you'll need to invest a larger sum of money upfront. It is not uncommon to hear of hedge funds having minimum investments of S$100,000 to S$1,000,000.

Many alternatives also have substantial ongoing fees and expenses that can affect returns. For instance, most actively managed funds charge an annual management fee equal to 2% of your investment and 20% of actualised profits above a hurdle rate¹.

3. Lower Liquidity with Greater Risks

Besides higher minimum commitments, most alternative assets are illiquid, meaning they cannot be easily bought or sold. Lock-in periods could be a few months to a few years, and withdrawals may be subject to queues and quotas.

There may not be any public or private exchanges for many alternatives. Combined with a small pool of market participants, investors can find it difficult to exit their investment quickly if needed.

4. Difficulty In Valuation

Estimating the fair value of alternatives may be complex as there aren’t enough eyes looking at the problem or there are no credible forums to exchange views.

A relative lack of historical, macroeconomic, company or industry data may also compound the complexities of researching alternative assets. Investors may need deeper financial and business knowledge to evaluate prospective investments in the sector.

Who Can Invest in Alternative Investments in Singapore

Many jurisdictions typically limit access to alternative products and derivatives to institutional investors and high-net-worth individuals who can assume the increased risk.

You may need to be an Accredited Investor to engage in certain alternative investments such as hedge funds and private equity.

However, not all alternatives are off-limits to the average retail investor. Individuals can consider the following:

• Commodities trading through Singapore Exchange (SGX)
• Venture capital in start-ups with smaller check size requirements (sub SS$10,000) by participating in angel investing syndicates.

Things to Consider Before Getting Started in Alternative Investments

As a summary, here are four key takeaways to consider before deciding to add alternatives to your portfolio:

• 1. Investment objectives: Do you wish to diversify your portfolio, mitigate volatility, and potentially achieve more robust returns at the cost of higher risks of knowledge, access, and the potential to make mistakes?
• 2. Investment horizon: Many alternatives are medium- to long-term plays of five years or more. Fund managers may also recommend reinvesting capital to compound returns. Can you commit to this time frame?
• 3. Illiquidity tolerance: How much of an alternative investment as a proportion of your overall portfolio are you willing to lock up? To make such assessments, you can derive metrics such as equivalent months of income or spending.
• 4. Expertise and resources: Besides banks and fund managers, some alternatives, like antiques and collectibles, may require specialized knowledge and networks. Do you have an expert to advise and guide you?

Have A Conversation about Alternative Investments with Citi

When it comes to investing, several different approaches can be taken. While some investors prefer to stick with traditional investments like stocks and bonds, others are drawn to the potential rewards of alternative investments like hedge funds and private equity.

Enjoy personalised wealth management advice and more with Citigold Singapore. Our specialised wealth management team can provide exclusive market insights and advice so you can make informed decisions about your investments and strategies. Speak to a Relationship Manager to get started on your investment journey today.

Notes: 1. A hurdle rate is defined as the minimum return a hedge fund must achieve before the asset manager can charge a performance fee to the investors.

Disclaimers

This article is for general information only and is not intended to be a forecast of future events nor a guarantee of future results and should not be relied upon as financial advice. All views and opinions are as of the date hereof, and are subject to change based on market and other conditions without notice. The article has no regard to the specific objectives, financial situation and particular needs of any specific person. It is neither an offer nor a solicitation to purchase, nor endorsement or recommendation of any products or services mentioned therein, and the products or services mentioned may or may not be offered by Citibank Singapore Limited, its related entities and their respective directors, agents and employees (together "Citigroup").

This article and its contents do not constitute the distribution of any information or the making of any offer or solicitation by anyone in any jurisdiction in which such distribution, offer or solicitation is not authorised or to any person to whom it is unlawful to distribute such information or make any offer or solicitation. 

Citigroup is under no duty to update this article and shall not be liable for any complaint, suit, action, claim, expense, loss or damages directly or indirectly arising out of or in connection with any person’s reliance on, or acting upon, or use of, any contents on this article. The article is subject to amendment without notice. Investment Products are (i) not insured by any government agency; (ii) not a deposit or other obligation of, or guaranteed by, the depository institution; and (iii) subject to investment risks, including possible loss of the principal amount invested. The information contained herein is not intended to be tax or legal advice, or an exhaustive discussion of the strategies or concepts mentioned herein. Please seek advice from your tax, legal or financial adviser as appropriate about the contents discussed herein or before investing in any investment products. Should you choose not to seek such advice, you should carefully consider the risks associated with any investments and make a determination based upon your own particular circumstances and assess whether such investment product is suitable for you.