Defining alternative investments

“For private investors, the term alternative investments (AI) has traditionally referred to a wide range of non-mainstream investment classes,” says Brett Williams, managing partner at Old Burlington Investments. He suggests these classes include such assets as structured products, luxury valuables and collectibles such as fine art and wine, hedge funds, managed futures, precious metals and forestry.

Adrian Lowcock, senior research analyst at Hargreaves Lansdown, says the definition can be widened to include “anything that is collectable but not deemed to be a financial investment or rather cannot be valued using typical financial analysis”.

“I would probably go further and say any investment where there isn’t a recognised exchange, so could include private equity.”

Indeed, specific methods of investing such as hedge funds are widely accepted in many people’s definitions of alternative, while some definitions even go so far as to consider certain geographic regions, such as emerging global markets, as alternative assets.

Quoted in the Alternative Investment Management Association’s 2012 Roadmap to Hedge Funds, Richard Bookstaber says: “The hedge funds/alternative investment moniker is a description of what an investment fund is not rather than what it is. The universe of alternative investments is just that – the universe.”

But Mr Williams points out that many AIs may not necessarily be suitable for the general public due to their complex makeup and the skill needed to value them.

“AIs typically have a low correlation with traditional financial investments such as stocks and shares. It may be difficult to determine current market values for many AIs.”

He notes that AIs are often highly illiquid and expensive to buy and sell. Frequently they lack much historical data on which analytical decisions can be based.

“As a result these investments tend to expose investors to greater risk at the same time as greater growth opportunities.”

But he adds that it is these characteristics that can also make AIs a valuable tool for portfolio diversification. “They can generate superior returns, especially at a time when mainstream market investments are delivering sub-optimal returns.”

And Aima says attitudes to alternatives have changed markedly since 2008 such that hedge funds are now a truly institutional product used by pension funds as a means to diversify away from their traditional bond/equity portfolio construction, and to seek superior risk-adjusted returns. “The industry is arguably better understood, more transparent, better governed, and, as a result, more respected to service an institutional investor base.”

But Mr Lowcock concludes that the regulatory coverage of this area is “next to nothing” and the FSA may only regulate the marketing of AI funds.

“The FSA concentrate on mainstream investors, they will cover authorised funds which may have limited exposure to alternatives.”