Alternative Investments - Meaning, Types and Advantages (2024)

All financial assets other than the conventional investment options are termed alternative investments. These alternative investment options can be tangible such as gold or real estate or intangible like hedge funds and private equity.

In this article, we will delve into the world of alternative investments, explore the various types and look at their advantages and disadvantages.

What are alternative investments?

Alternative investment is the term used to refer to all investment options outside the realm of traditional investment categories, such as bonds, stocks, mutual funds, and cash. Alternative investment options often have a low correlation to traditional investments, meaning they do not move in tandem with the broader financial markets. This makes them an attractive investment option to some investors since they offer diversification and protection against market volatility and downturns.

Alternative investments: An example

Now that you know the meaning of alternative investments, let us look at a hypothetical example to help you understand the concept.

Real estate is one of the most popular alternative investment options in India. When you purchase a property such as a piece of land, a house or even a building, you essentially invest in real estate.

The value of real estate properties depends on factors other than the movement of financial markets. So, even if the financial markets are going through a bearish phase, your real estate investments will not lose value unless the real estate market is also going through a downturn.

As you can see, investing in real estate can effectively diversify your portfolio and hedge your financial market risk, protecting you from the negative effects of adverse market movements.

Types of alternative investments and how to invest in them

In India, there is no dearth of alternative investments. Here are some of the most common types and how you can invest in them.

1. Real estate

Real estate is the term used to refer to tangible property such as land or buildings. The returns from these investments could be in the form of rental income, value appreciation or both.

There are multiple ways to invest in real estate. For instance, you can directly purchase properties or invest in Real Estate Investment Trusts (REITs). REITs provide exposure to the real estate market without having to own any property.

2. Commodities

Commodities are tangible goods or raw materials. They are often classified into different categories, namely precious metals (gold, silver), energy (oil, natural gas), agricultural products (corn, wheat) and industrial metals (copper, aluminium).

Purchasing physical commodities and trading in commodity derivative contracts on exchanges are two of the most popular ways through which you can gain exposure to these alternative investments.

3. Farmland

Investing in farmlands is a lucrative way to generate passive income, especially since India is primarily an agrarian economy. With farmlands, you can either earn rental income by leasing them to large-scale farmers or use the land to grow agricultural products. These products can then be sold in the markets to generate revenue.

4. Art and collectables

Art and collectables are among the least common types of alternative investments. Investors purchase items such as paintings and memorabilia whose historical value is expected to increase with time.

5. Cryptocurrencies

Cryptocurrencies have quickly become one of the most preferred alternative investments in India and the world. A form of digital currency, cryptocurrencies are created through blockchain technology. Many investors and experts are exploring these currencies as an alternative to fiat currency.
However, it is important to remember that cryptocurrencies are neither legal nor deemed to be illegal in India. Since there is no regulatory consensus around this alternative investment, it is advisable to tread with caution if you are planning to invest in them.

6. Hedge funds

Hedge funds are investment funds that use a range of high-risk investment strategies to generate returns. These funds have fewer regulatory standards and can be more flexible in their investment approach. Since hedge funds are not listed on the stock exchanges, you must approach the Asset Management Companies directly to invest in them.

7. Venture capital and private equity

Venture capital and private equity investments provide capital to early-stage startups and established private companies in exchange for equity ownership. Venture capital investments typically focus on high-growth companies, whereas private equity targets mature companies.

These alternative investments offer the potential for significant capital appreciation but involve significantly higher risks. Venture capital and private equity funds are not easily available for investment and require you to be an accredited investor with minimum net worth requirements.

8. Peer-to-peer lending

Peer-to-peer (P2P) lending involves lending funds directly to other individuals or small businesses, bypassing traditional financial intermediaries like banks. You can participate in P2P lending through registered online platforms that help you connect with potential borrowers. However, it is important to note that peer-to-peer lending involves several risks, such as credit risk, default risk and platform-specific risks.

Advantages of alternative investments

Alternative investments offer several advantages that make them appealing to investors. Here are a few of the benefits that these investments offer.

Diversification

Most alternative investments have little to no correlation with traditional investment options. This makes them ideal choices for diversifying your portfolio to reduce overall risk.

Potential for higher returns

Although alternative investments carry significant risks, they also have the potential to deliver market-beating returns. Hedge funds, private equity, and real estate are some examples of investments that have delivered significantly higher returns.

Hedge against inflation

Investments in real estate, commodities and infrastructure can act as a hedge against inflation because their value often increases with rising prices.

Passive income

Many alternative investments such as real estate and farmlands enable you to generate passive income through rent. This passive income is in addition to the capital appreciation you will likely enjoy over time.

How to invest in alternative investments?

The process you need to follow to invest in alternative investments will vary depending on the asset. Some of them can be relatively straightforward, whereas others may require you to satisfy a set of eligibility criteria.

Private equity

Private equity funds are usually only available to highly accredited investors, institutional investors and high-net-worth individuals. To invest in these funds, you need to approach a private equity firm that matches your investment goals. You may be asked to sign an agreement where you consent to commit your capital for a specified period. Till the specified period expires, you may not be able to withdraw your investment.

Real estate

You can invest in real estate by directly purchasing physical properties like land or buildings of a residential, commercial or industrial nature. Alternatively, if you are not interested in purchasing physical properties, you could consider purchasing units of a Real Estate Investment Trust (REIT).

REITs are unique investment vehicles that pool funds from multiple investors and use them to invest in real estate projects. These funds share the rental income from real estate projects with the investors at periodic intervals.

Hedge funds

Similar to private equity, hedge funds are also available only to institutional and accredited investors. Most hedge funds have minimum investment limits and lock-in periods. To invest in these funds, you need to approach a hedge fund and sign a subscription document where you agree to commit your capital to the fund for a specified period.

Commodities

Purchasing physical commodities like gold, silver and agricultural commodities is one of the most popular ways to gain exposure to these alternative investments. However, if secure storage of physical commodities is a major hurdle, you can also consider investing in commodity derivative contracts or commodity Exchange-Traded Funds (ETFs).

Art and collectables

Since art and collectables are susceptible to counterfeiting, it is advisable to purchase them from reputed auctioneers, galleries or art dealers. Also, consider getting the artwork or collectable professionally appraised to determine value and authenticity before committing to a purchase.

Cryptocurrencies

To invest in cryptocurrencies, you must open an account with a reputable cryptocurrency exchange. Once your account is opened, transfer funds and purchase your preferred cryptocurrency via the exchange. The currencies you buy will be stored in a dedicated high-security wallet to protect against hacking and theft.

Tax implications of alternative investments

The tax implications of alternative investments vary depending on the asset. For example, commodity derivatives, commodity ETFs, REITs, urban agricultural land, jewellery, art and collectables are classified as capital assets.

Capital assets, except commodity derivatives, ETFs and REITs, that are held for more than 36 months are classified as long-term capital assets. The gains from these assets are taxed as long-term capital gains (LTCG) at the rate of 10%. However, LTCG is only applicable if the gains exceed Rs. 1 lakh during a financial year.

Capital assets, except commodity derivatives, ETFs and REITs, that are held for less than 36 months are classified as short-term capital assets. The gains from these assets are taxed as short-term capital gains (STCG) at the rate of 15%.

In the case of commodity derivatives, ETFs and REITs, however, the holding period limit is 12 months instead of 36 months. This means that if you hold these assets for less than 12 months, they would be classified as short-term capital assets and subject to STCG. Alternatively, if you hold them for more than 12 months, they would be classified as long-term capital assets and subject to LTCG.

In the case of cryptocurrencies, a flat rate of 30% is levied on the gains you get from selling them.

Regulations for alternative investments

Compared to traditional investment options, the regulations surrounding most alternative investments are not as stringent. That said, hedge funds, private equity funds and venture capital funds are all covered under the Alternative Investment Funds (AIF) Regulations issued by the Securities and Exchange Board of India (SEBI). Similarly, commodity derivatives, ETFs, and REITs are heavily regulated by the SEBI.

Real estate, on the other hand, is regulated by the Real Estate Regulation and Development Act of 2016 and by the Real Estate Regulatory Authority (RERA). Meanwhile, art and collectables, cryptocurrencies and peer-to-peer lending are currently completely unregulated by any authority.

Therefore, if you are planning to invest in alternative investments with little to no regulations, it is important to exercise maximum caution since may be prone to manipulation or fraud.

Disadvantages of alternative investments

As an investor, understanding the various drawbacks of alternative investments is important since it can help you make informed investment decisions. Here is a quick overview of some of the key disadvantages.

Illiquidity

Many alternative investments, such as real estate, art and collectables, cannot be easily sold or converted into cash. In the case of private equity, venture capital funds and hedge funds, there are long lock-in periods during which your investments cannot be liquidated.

High costs

Compared to traditional options, alternative investments typically involve higher fees. Hedge funds, for example, often charge a management fee and a performance fee. In the case of real estate, stamp duty and registration costs can be quite significant.

Less transparency

Since many alternative investments are not as regulated as traditional investment options, they are often less transparent regarding their operations and performance.

High risk

Alternative investments can be highly speculative and susceptible to market fluctuations and economic changes. If the conditions are unfavourable, you could incur significant losses.

Valuation challenges

Accurately assessing the true worth of art and collectables can be very challenging due to the lack of standardised valuation principles.

Conclusion

Investing in alternative investments is a good way to diversify your investment portfolio. These investments often have little to no correlation to the financial markets, meaning they will not be affected by downturns. However, it is important to note that alternative investments may not be strictly regulated like stocks, bonds or mutual funds. This makes them very risky investment options. Therefore, it is advisable to ensure that you thoroughly understand the various risks involved with the investments before making a decision.

On the other hand, if you prefer regulated investment options, you can consider investing in mutual fund schemes. On the Bajaj Finserv Mutual Fund Platform, you can find more than 1,000 funds from some of the leading Asset Management Companies (AMCs) in India. Furthermore, you can also compare mutual funds and determine the returns you are likely to get from your investments using SIP calculator and lump sum calculators.

Essential tools for mutual fund investors