Traditional Vs. Alternative Investments- Understanding The Risks

When it comes to investing your hard-earned money, there are many available options. The possibilities seem endless, from stocks and bonds to real estate and commodities. But what about alternative investments? Are they worth considering?

Let us deep dive and understand the risks involved with alternative investments compared to traditional investments and how to mitigate those risks for creating an inflation-beating portfolio.

Overview Of Alternative Investments

You can think of alternative investments as the rebels of the investment world. They go beyond the usual investment avenues like stocks, mutual funds, fixed deposits, gold, and bonds. Alternative investments encompass many assets, including private equity, hedge funds, real estate, securitised debt instruments, venture capital, art, collectibles, etc.

Alternative investments break the traditional mould and offer investors a different path to diversification and potentially higher returns. Alternative investments encompass a wide range of assets and strategies that are less conventional and often operate outside the public markets. Here is what you need to know about alternative investments:

1. Direct Ownership And Private Investments: Alternative investments like private equity, hedge funds, real estate, and venture capital often involve direct ownership of physical assets or investments in private companies. This direct ownership or involvement in private enterprises sets them apart from publicly traded stocks and bonds.
2. Lower Liquidity: Alternative investments typically have lower liquidity than traditional investments. While stocks, bonds, mutual funds and commodities are easily tradeable, alternative investments often have longer lock-up periods. This means that once you invest in alternative assets, it may be more challenging to sell or exit your position quickly. Investors should be prepared for potential limitations on liquidity when considering alternative investments.
3. Complex Regulations And Structures: Alternative investments can be subject to more complex regulations and structures than traditional investments. For example, private equity investments may involve limited partnerships or other legal structures that require careful consideration. Additionally, alternative investments may have unique tax implications and reporting requirements. It is essential to thoroughly understand these complexities before investing in alternative assets.

Are Alternative Investments Safe?

Alternative investments are considered safer than market-linked options like stocks and mutual funds but riskier than India’s preferred investment tools like gold and fixed deposits.

Certain risks like market, credit, and liquidity risks are attached to them. Let us understand these risks and how safe alternative investment tools are for investing.

• Market risk is the probability of incurring losses on financial investments due to adverse price movements or changing economic conditions like demand-supply imbalance, rise in competition, etc. They are related to alternative investments like private equity, commodities, etc., where the returns are not fixed.
• Credit risk refers to the companies’ inability to pay back the debt due to limited cash flows. In worse cases, the total investment of lenders may become zero. 
• Liquidity risk refers to a company’s inability to convert its assets into cash if needed. Alternative investments are highly illiquid and have a lock-in period before investors can withdraw their money.
• Interest rate risk refers to potential loss in investment return due to changing interest rates. For example, you may have purchased a fixed-income investment at x% for five years; however, the prevailing interest rate on new purchases can be (x+y)% based on the Reserve Bank of India’s monetary policy. Since alternative investments are illiquid in nature, you will lose an extra y% return for the remaining period of investment.
• Default Risk (Probability of Default or PD) refers to the borrower’s inability to follow the terms of the loan agreement.

Checklist For Evaluating Alternative Investments

Now, let us talk about how you should evaluate alternative investments before committing your money.

1. Assess the risk and return potential of the investment. It is crucial to understand the upside potential as well as the downside risks. Look at historical performance and projections to get a clear picture.
2. Do not forget to evaluate the issuer's expertise and financial track record. As a business entity, their model should be scalable and profitable. As management, they should possess the skills and experience necessary to navigate the alternative investment landscape successfully.
3. Transparency and due diligence are the keys. Dig deep into the investment's financial statements, legal documentation, and underlying assets. The more you know, the better equipped you will be to make an informed decision.
4. Consider the liquidity and exit strategy of the alternative investment. Unlike stocks, alternative investments often have longer lock-up periods and limited exit options. Ensure you are comfortable with the time frame and understand the potential constraints.
5. Take a close look at the fee structure associated with the investment. High management fees, performance fees, and other expenses can eat into your returns. You want to ensure that the fees are fair and aligned with the value provided.

Conclusion

Alternative investments can bring advantages to your investment portfolio beyond the traditional options. They allow diversification, which helps reduce your overall risk, especially when the equity market is going through a rollercoaster. However, no asset class is 100% risk-free, including the alternative investments. Understanding the risk factors and taking preventive measures is necessary to reap the benefits.

Since research and due diligence at the individual level may get overwhelming and time-consuming, online discovery platforms like Grip Invest bring detailed coverage of risks involved with various alternative investment assets. Explore Grip Invest to research SEBI-regulated, credit-rated and curated alternative investments.

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Disclaimer - Investments in debt securities are subject to risks. Read all the offer-related documents carefully. The investor is requested to take into consideration all the risk factors before the commencement of trading. This communication is prepared by Grip Broking Private Limited (bearing SEBI Registration No. INZ000312836 and NSE ID 90319) and/or its affiliate/ group company(ies) (together referred to as “Grip Invest”) and the contents of this disclaimer are applicable to this document and any and all written or oral communication(s) made by Grip Invest or its directors, employees, associates, representatives and agents. This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest does not guarantee or assure any return on investments and accepts no liability for the consequences of any actions taken based on the information provided. For more details, please visit https://www.gripinvest.in/. 
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