There’s an easy way to tell the difference between a retail investor and a sophisticated investor: look at the level of diversification in their portfolio.
If you see domestic stocks, government bonds, corporate bonds, and maybe a few foreign stocks, you’re dealing with a retail investor.
If you see non-standard investment classes like commodities, private equity, venture capital, real estate, and tangible assets (art, artifacts, cars, rare coins, oil, etc.), congratulations, you’re in the hands of a sophisticated investor.
The difference between the portfolio of a sophisticated and that of a retail investor is night and day. There are many reasons for this.
The most obvious is that some of these alternative investments have traditionally only been available to Accredited Investors. Today, crowdfunding and other new regulations have opened a few doors but, for the most part, the retail investor has yet to invest in these classes. And even still, some alternative investments continue to be reserved and marketed only to Accredited Investors.
Why are alternative investments so attractive to sophisticated investors?
One reason is these assets generally demonstrate a low correlation with the global financial markets, which can help stabilize portfolio volatility.
Also, while the S&P typically yields a long-term average of 7% per year, alternative investments allow for the possibility of much larger returns. The downside is that these classes are generally less liquid and tend to be riskier than stocks and bonds.
If you’re used to investing only in stocks and bonds, here are the seven main types of alternative investments you might want to be aware of:
1. Private Placement Bonds
This type of debt is not traded publicly and is often not rated by a third-party agency. So, you have to know what you’re doing to invest in this space.
Promissory notes or “mezzanine” debt are often used to fund growth and acquisitions for mid- and late-stage startups. It can provide investors with steady cash flow (assuming the borrower doesn’t default).
2. Angel Investing
You’ll have to be well-connected and highly savvy to pull off a successful angel investment. But if you do, you could be looking at returns of over 500-1000x.
Angel investors provide seed capital for early-stage startups at a low valuation and generally accept a seat on the board. These investments are less liquid than bonds, and successful “exits” are rare but lucrative. Angel investments have a more significant margin of losses per investment than most other alternatives.
3. Private Equity or Venture Capital
These investments have become very “sexy” lately, especially in and around the startup culture of Silicon Valley. The idea is that this is a less risky and more stable version of angel investing and private placement.
Private equity or a venture capital firm will raise a round of funding from wealthy investors and then use that capital to invest in a portfolio of private companies and pooling the risk (and potential upside).
4. Real Estate
Income-producing real estate is an excellent addition to any portfolio. Apartment buildings, industrial, residential, and other classes can all generate steady short-term revenue while simultaneously increasing in value over the long-term.
For investors interested in investing in real estate, one of the most popular forms is private real estate funds, partnerships, or syndications.
5. Precious Metals and Gems
Rare gems and metals like gold, silver, and platinum are generally considered to be a safe investment because they have intrinsic value and can buffer against volatility.
This is why central banks often hold gold as a reserve asset. However, the potential upside from holding precious metals and gems is low compared to other types of alternative investments, and they do not offer an income component.
6. Timber, Oil, and Natural Gas
Commodities and commodity futures fluctuate in price based mainly on supply and demand dynamics. This means commodities are generally more volatile than stocks and precious metals.
The price of soybeans, for instance, can vary widely based on crop yields, production needs, consumer preferences, and supply chain issues. Some exchange-traded funds specialize in commodities. This class is vulnerable to tariffs, and it’s more tightly correlated with Wall Street.
7. Art, Antiques, and Collectibles
It’s often hard to know what a certain piece of art or a collectible item is truly worth, but if you pick a winner, the upside can be substantial. Because these assets are generally one-of-a-kind, their value is highly subjective and can vary widely from year to year depending on who is bidding.
The economy and sudden fluctuations in investor demand for some collectibles and art adversely affect this investment with little warning.
While many sophisticated investors diversify with alternatives, it’s important to know your end goal.
Are you seeking income and growth? Are you seeking a hedge against inflation? Are you searching for investments which are not closely correlated to the changes on Wall Street?
For these reasons, we overwhelming choose to invest in commercial real estate as it is the best channel to meet the goals of our investors.
Click here to learn more about the opportunities that we offer to sophisticated investors.
Invest for Success,
Kent Leach
