What Kind of Alternative Investor Are You?
Published March 14, 2013
Is Alternative Investing for You?
Board-Game Banker: Peer-to-Peer Loans
Artist: Invest in Art and Rarities
Do-Gooder: Impact Investments
Income Investor: Closed-end Funds
Accredited Investor: Private Offerings
These investments are mainly offered to the wealthy, but small investors can get in on some.
1Is Alternative Investing for You?
If you're sick of stocks and bored by bonds, the universe of nontraditional investments could be for you -- or for part of your portfolio. In general, investments beyond the traditional stocks, bonds and cash are known as alternative asset classes and some experts say they could give your investing an edge.
Alternative asset classes offer a wide range of possibilities, from racehorses and classic cars to commercial real estate and private equity. Commodities, futures contracts and real estate investment trusts also qualify as alternatives. Varying strategies using conventional investments may also be considered alternative.
There's a lot out there -- but don't rush out to invest in a mint Shelby Cobra roadster just yet; realizing a return can be difficult in some markets. Investment returns for rarities and collectibles are never guaranteed. And small-time investors may find themselves shut out of some alternative investments. Many are only available to accredited investors -- those with a net worth of $1 million or an annual income of $200,000 for two years in a row, according to the Securities and Exchange Commission, or SEC.
Though many alternatives are geared to the well-heeled, some alternative investments may fit your personality as well as your pocketbook.
Be advised that alternative asset classes are not appropriate for everyone. Check your risk tolerance and objectives before investing in new opportunities.
2Board-Game Banker: Peer-to-Peer Loans
If you're always playing the banker in Monopoly or just want regular interest payments that will keep up with inflation, then peer-to-peer lending might be for you. Peer-to-peer loans have existed on the Internet since 2006 with the launch of the first online peer-to-peer loan platform.
The basic formula across peer-to-peer loan companies involves an online application process for borrowers after which they're assigned a credit score and an interest rate for their loan -- if they're approved. Lenders can look over the borrower biographies to choose individual loans in which to invest or they can set criteria such as loan length and credit ratings and have their money funneled into the best options for instant diversification.
According to the sites, the returns aren't too shabby. Lending Club boasts 5.61 percent returns on A-rated loans as of mid-February, according to its website. On the Prosper website, another peer-to-peer loan platform, select AA loans show a 5.5 percent return and a yield of 7.2 percent as of Dec. 31, 2012. On the next rung down the credit ladder, select A-rated loans return 6.25 percent and yield 9.34 percent.
"Lenders have made an average of over 9 percent. And in general, all lenders that have invested in 100 or more loans have all made money," says Kirk Inglis, chief operating officer of Prosper.
Take note that it's not a riskless investment: Some borrowers do default on their loans.
3Artist: Invest in Art and Rarities
If you have deep pockets, collectibles such as art and rare wines can be great investments. For the merely wealthy, private art funds have been around since about 2000. The British Rail Pension Fund was the first to try out the idea, starting in 1974, according to the Art Fund Association. The new idea these days is public art funds that anyone will be able to buy. They're not available yet but are in the works by the company Liquid Rarity Exchange, which will license the funds to investment bankers.
"There are several private funds in various rarity sectors, but it's limited. It's limited because the entrance price is $250,000. It could go up to well beyond $1 million and the average investor can't invest," says Michael Saigh, managing partner and CEO at Liquid Rarity Exchange.
That firm developed the architecture and technology to let mutual funds or exchange-traded funds own a collection of art and collectibles. Fund managers can sell shares regularly or add to their positions according to the fund objective and strategy.
"The real key is now there's liquidity where in private funds, there's not. You wouldn't be buying a share of one Picasso. It would be a share of the overall fund with lots of different paintings in it," Saigh says.
4Do-Gooder: Impact Investments
If you're trying to save the world and also have some money to invest, the field of impact investing has some options. Sustainable, responsible and impactful investments, also known as SRI (formerly called "socially responsible"), are available as traditional mutual funds. But impact investments can be a different animal: Investors have the specific intent of making a positive social or environmental impact, with some return on their money.
Impact investments can be made in "developed markets such as the U.S. and Europe as well as emerging markets such as sub-Saharan Africa and India. They can target a wide variety of sectors. It can be anything from sustainable agriculture to affordable housing, microfinance and things like access to clean water or renewable energy," says Amit Bouri, managing director of the Global Impact Investing Network.
Though most of the opportunities in this realm are for accredited investors, there are ways that small investors can help. The Calvert Social Investment Foundation offers its Community Investment Note portfolio that lends out principal to underserved communities. When the note matures, you get your principal back with interest. There are no guarantees, but Calvert reports that none of the investors in its Community Investment Note portfolio have ever lost money.
Calvert isn't the only company to offer microfinance investments; other issuers of similar notes are available through the brokerage platform MicroPlace.
5Income Investor: Closed-end Funds
If you're looking for income but don't want to go too far afield, take a look at closed-end funds. They aren't alternative investments, but they do have a structure different from their popular brethren -- open-end mutual funds. And they employ some techniques that can amplify returns (or losses).
Like ETFs, closed-end funds trade on an exchange. Unlike open-end mutual funds, redemptions are not done through the mutual fund company once a day but instead shares are traded in the market throughout the day. As a result, the market determines the value of the fund, so closed-end funds often trade at a premium or a discount, or above or below, the actual value of the underlying investments.
Not all closed-end funds invest in fixed-income securities, but most of them do, says Morningstar's closed-end analyst Cara Esser.
"The majority of the universe is fixed-income and the majority of that universe is municipal bonds. And then within fixed income there are a lot of different strategies that they can use: bank loan funds, preferred share funds, high-yield emerging markets, precious metals and gold funds," Esser says.
Most closed-end funds, even on the equity side, focus on income generation, and a majority of them use leverage to increase it.
6Accredited Investor: Private Offerings
For the highly speculative business of investing in unproven companies, the SEC only allows accredited investors. That may change once the regulator formulates rules on equity crowd funding, or selling small amounts of equity to many investors, as allowed by the Jumpstart Our Business Startups, or JOBS, Act, passed in 2012.
Until then, private offerings are currently only open to accredited investors. But technology has recently given the process a new twist. MicroVentures is a full-fledged broker dealer with an online investment platform for investors interested in startups. It's currently limited to the well-heeled investor and the investment options are fully vetted.
On the MicroVentures website, accredited investors can peruse the offerings online and invest between $5,000 and $30,000 in return for shares in a startup. After that the SEC enforces specific and complicated rules about selling restricted securities.
"If it's still a private company and there is liquidity, they have to hold it for a year or get a legal opinion. After a company goes public there is a lock-up period, usually 180 days for pre-(initial public offering) investors, but it depends on the company and who the investor is and how much they invested," says Tim Sullivan, CEO at MicroVentures.
MicroVentures has funded some well-known companies, including Twitter and Yelp.