What are alternative investments?

Once considered a more niche form of investing, alternative investments are moving firmly into the mainstream. These unconventional forms of investments have become increasingly popular among investors keen to diversify their portfolios. But what are alternative investments, exactly, and how do they differ from more traditional investment types? We take a closer look.

When we talk about investments, most people think of stocks, shares, cash, and bonds—these are considered traditional investments. Definitions of what constitutes a traditional asset class can vary, so you might sometimes see property and equity included among the traditional investment types.

An alternative investment is basically any kind of investment that doesn’t fall into these more typical investment categories. Because they provide so many different ways to invest, investors use them to diversify their portfolio and potentially improve their returns.

Alternative investments offer a range of unconventional ways to potentially grow your wealth, beyond the usual stocks and bonds. You might be familiar with some of these already, like real estate or commodities such as precious metals and oil—these are classic examples of alternative assets.

Other ways to invest in alternative assets include:

• Private equity and hedge funds: These options involve investing in private companies or funds not traded on public markets. They can offer high returns but come with increased complexity and risk.

• Structured products: These are tailored investment strategies that combine various financial instruments to meet specific financial goals, offering customised solutions for investors.

• Binary options and contracts for difference (CFDs): Binary options offer fixed payouts based on certain conditions, while CFDs let investors speculate on asset price movements without actually owning the assets.

• Crowdfunding: By pooling funds with others, investors can support new projects or startups, gaining exposure to innovative ventures.

• Peer-to-peer lending: This allows you to lend money directly to individuals or businesses through online platforms, offering an alternative to traditional banking.

• Cryptocurrencies: Digital currencies operating on decentralised networks represent a modern, evolving field of investment with high potential but significant volatility.

• Farmland: A blend of real estate and commodities, investing in farmland means investors have the chance to earn a regular income if the farm’s produce and sales are profitable.

• Collectibles and artwork: If you have a unique hobby, you may be making alternative investments without even realising. Collections of art, memorabilia, and other items are considered alternative assets as they can increase in value over time.

An alternative investment fund (AIF) is a type of investment where money from multiple investors is pooled together to invest in non-traditional assets like private equity, real estate, or hedge funds. Unlike investing in these assets individually, AIFs give you a way to access a variety of them all at once.

What makes alternative funds stand out is their regulated setup. Special EU regulations are in place to make sure AIFs are managed properly and transparently. They can be a structured way to invest in alternative assets, often with better diversification and risk management than going solo.

This table outlines the main differences between the two:

Alternative investments aren’t for everyone. They are primarily intended for institutional investors (for example pension funds and hedge funds), as well as high-net-worth individuals known as accredited investors. Alternative assets are generally not made available to the general public due to their high risks.

To give an idea of the risks with alternative investment management, the Central Bank of Ireland actually restricted the sale of CFDs and binary options to retail investors. This decision was based on research showing that many retail investors had made losses with these alternative assets.

Alternative investment funds are another example. They are designed for investors with substantial financial resources and a strong grasp of investment risks. These kinds of investors are better equipped to handle potential losses without severe financial consequences, unlike less experienced investors with smaller financial cushions.

For most people, the risks associated with alternative investments make them less appropriate compared to traditional options like stocks and bonds.

As we’ve seen, effective alternative investment management requires a deep understanding of non-traditional assets and strategies. Whether it’s a good idea or not ultimately depends on the investor’s financial situation, their level of knowledge, and their ability to manage the associated risks.

Here are some advantages and disadvantages to consider:

Advantages

• Diversification: The sheer range of non-traditional asset types can add variety to your portfolio.

• Potential for higher returns: They may offer the chance for better returns compared to traditional investments.

• Hedge against inflation: Alternative assets like commodities or real estate can protect against inflation by maintaining or increasing value as prices rise.

Disadvantages

• Higher risk: They come with greater risks due to their complexity and potential for significant losses.

• Illiquidity: Alternative investments can be harder to sell quickly.

• Higher costs: They usually come with higher fees and require specialised knowledge to manage effectively.

Alternative investments come with several risks worth considering. Firstly, they can be sensitive to changes in the economy and inflation, which can cause their value to fluctuate. Their returns can be unpredictable and affected by interest rate changes, which might make them less appealing at times.

These investments might use borrowed money or other financial techniques, which adds another layer of risk. They can be hard to sell quickly if you need to cash out (known as illiquidity). And since they are often subject to different rules and regulations, their performance can be affected in ways you might not expect.

Because alternative investments span such a wide range of asset types, their average returns can vary considerably. Generally, they offer the potential of higher returns compared to traditional investments, but this is of course due to their higher risk.

However, keep in mind that private equity and hedge funds often come with high management and performance fees, which can eat into any returns made. Unlike many traditional investments that might have lower transaction costs and sometimes no fees, alternative investments often involve higher costs and minimum investment requirements.

In Ireland, alternative investments are taxed differently compared to traditional asset classes like stocks and bonds. How much tax you pay varies based on the type of alternative asset.

• Real estate: When investing in property, you pay Capital Gains Tax (CGT) at a rate of 33% on the profit when you sell the property. Rental income from real estate is taxed as ordinary income, which can reach up to 40% depending on your total earnings.

• Private equity and hedge funds: These investments are usually subject to an Exit Tax of 41% on the gains when you exit the fund. This tax applies to the profits you make, regardless of how long you hold the investment.

• Peer-to-peer lending: Income from peer-to-peer lending is treated as interest income and is taxed at the same rates as ordinary income, up to 40%, plus any applicable Universal Social Charge (USC) and Pay Related Social Insurance (PRSI).

With all these different tax rules, it can help to contact a tax advisor so you understand what will apply in your case.

When considering how much to invest in alternative assets, it’s common to see recommendations ranging from 15% to 30% of your overall portfolio. Some investors with substantial financial resources or long-term goals might choose to allocate even more, up to 50% or beyond. 

There’s no single right answer here. When it comes to alternative investment management, investors usually try to find a balance that matches their risk tolerance and investment objectives.

In Ireland, alternative investments are regulated to ensure proper and transparent management. The Central Bank of Ireland oversees the regulation and authorisation of various investment vehicles, including unit trusts, investment companies, and partnerships.

For alternative investment funds, the Alternative Investment Fund Managers Directive (AIFMD) sets additional rules. Alternative funds must adhere to strict organisational and operational standards, ensuring transparency and ethical business conduct.

Coming with a higher level of risk, alternative investments aren’t for everyone. Putting some of your money away in a fixed deposit account will give you the security of a guaranteed return on your deposit. Plus, you benefit from having up to €100,000 of your funds protected, per bank. At Raisin Bank, we offer some of the best fixed term deposit rates on the market. Register for free to get started.

This information does not constitute financial advice. You should always do your own research to ensure that investments are right for your specific circumstances.