Understanding alternative investments
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What are alternative investments?
Canadians are living longer, and that means sponsors and advisors are looking for ways to seek greater diversification and improved outcomes–and alternative investments might be the answer. Because this may be new territory for retirement professionals, we’ll share what alternatives are and how they compare to traditional assets.
What’s considered an alternative investment?
When you think of investments, you probably think of stocks, bonds, and cash. These are traditional assets. Alternative investments represent a distinct category and include assets like real estate, infrastructure, and even collectibles. They can have higher returns–but also higher risk
What are some types of alternative investments?
Private asset alternatives are investments in companies, projects, or properties that don’t trade on public markets. So, instead of buying shares on the open market, qualified investors enter into negotiations directly with sellers, also known as the private market. Generally, private market transactions require a long-term commitment from the buyer, with deposit and redemption requirements that make their investment harder to trade. Investors are offered an illiquidity premium, which is the extra return they can expect for holding assets that can’t be easily or quickly sold.
Private asset alternatives include private equity, where investors buy ownership in private companies and may share in their future profits, and private credit, where investors lend money directly to companies in return for interest payments and the return of their initial investment (principal) at a specific date (maturity).
What are some examples of private assets?
Private equity examples | Investment focus |
Growth equity | Invests in well-established companies looking for capital to expand their business; typically less risky than startups but still offers strong growth potential |
Leveraged buyout | Acquires controlling stakes in mature, stable businesses; often uses a mix of equity and borrowed money (leverage) to purchase a business and then works on improving operations, increasing profitability, and eventually selling the business for a gain |
Venture capital | Invests in early-stage, high-growth companies that may carry more risk, but offer higher return potential than mature companies |
Private credit examples | Investment focus |
Asset-based lending | Loans backed by collateral, such as inventory, equipment, or receivables |
Direct lending | Loans made directly to small or midsize businesses that may not be able to borrow from traditional banks |
Venture debt | Loans made to early-stage, high-growth companies that are backed by venture capital |
What are some examples of real assets?
Real asset type | Examples |
Collectibles | Art, antiques, coins, stamps, and memorabilia |
Commodities | Gold and crude oil |
Infrastructure | Roads, bridges, power lines, corn fields, and cellular towers |
Real estate | Commercial buildings, apartments, and office space |
Timber and agriculture | Farmland and forestry |
How do alternative investments compare to traditional assets?
Category | Traditional assets | Alternative assets |
Accessibility | Widely available to individual investors and DC plans | Widely available to qualified investors and institutions, including defined benefit pension plans, and limited access to defined contribution (DC) plans |
Market correlation | Generally move in the same direction as the broader market | Generally don’t move in the same direction as the broader market |
Diversification benefits | Generally a mix of stocks, bonds, and cash is used to help offset losses from any single asset class | When added with a mix of traditional assets, alternatives can help boost diversification, which may lead to higher potential returns and lower volatility over time |
Return drivers | Varies. Generally, price appreciation, dividends, interest income, and repayment of principal | Varies. Generally, income from rent or interest, capital appreciation, and illiquidity premiums |
Investment horizon | Short- to long-term | Medium- to long-term |
What’s next for alternatives?
When integrated into a traditional retirement portfolio, alternatives can help deliver greater diversification, higher return potential, inflation protection, and smoother volatility over time. However, there is risk and each investor must weigh the pros and cons of these assets before making a decision.
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