Apart from the major asset classes of cash, fixed interest and Australian and international shares, there are a number of alternative assets available to investors.
Alternative investments are generally more complex, and may be structured to include features of more than one asset class. While alternative investments often involve higher risk than some other asset classes, some alternative assets are structured to reduce volatility.
Before investing in any alternative investment, it is important to fully understand how the investment is structured and how it works.
Some alternative investments include:
- derivatives such as options, warrants, futures and CFDs
- hedge funds, and
- venture capital and private equity.
Derivates are investments that derive their value from an underlying asset such as shares. Derivatives are generally used to hedge the risk of unfavourable movements in the underlying asset’s price, but are also popular with speculators looking to leverage a higher level of exposure in the underlying asset.
Examples of derivatives include:
- Call options – give the option holder the right to buy the underlying shares at a future date (without obligation)
- Put options – give the option holder the right to sell the underlying shares at a future date (without obligation)
- Warrants – give holders the right to buy or sell the underlying asset, such as shares
- Futures – a contract to buy a specified asset at a future date at a price determined at the time of the contract, and
- Contracts for difference (CFDs) – where the holder receives, or pays, the difference in price of the underlying security between the time the contract opens and closes.
Some derivatives are traded on-market through the ASX, while others are traded in the ‘over-the-counter’ (OTC) market where institutions and corporate investors trade directly with each other.
Hedge funds are managed investments that invest in a range of underlying assets, including derivatives, to achieve absolute (positive) returns in all market conditions rather than simply aiming to outperform a specified benchmark such as the S&P/ASX 200. Hedge funds use a range of investment techniques including leverage and short selling (borrowing and then selling overvalued shares in anticipation of a fall in the share price where the shares are then bought back).
As most hedge funds are unlisted, they generally have lower liquidity than other managed investments and it is harder to track the daily value of your investment. There may also be rules restricting withdrawals for a certain period. The minimum investment amount may also be restrictive to many investors.
Hedge funds are generally considered most appropriate for sophisticated investors and should only be considered as part of a diversified investment portfolio.
Private equity and venture capital
Private equity and venture capital is investment typically in unlisted companies considered to have high growth potential, with the aim of building and increasing the value of the company over a period and then selling the investment for a profit. Private equity is usually categorised as investing in companies in the expansion and buy-out stage whereas venture capital usually involves investing in start-ups or companies in the early stages of development