Investors have many options when it comes to building a diversified portfolio. These options may include stocks, bonds, cash, etc. However, some investors may go beyond these options to maximize their returns or for diversification. These may include options such as private equity, private debt, real estate, etc. These constitute types of alternative investments.
What is an Alternative Investment?
The term alternative investment signifies an investment that does not fit in the same category as other conventional investments. Usually, when investors think of investing, they consider stocks, bonds, or cash. However, many other investment categories do not fall in the same group. As mentioned, these may include venture capitals, commodities, private equity, etc.
Alternative investments provide investors with an opportunity to diversify their portfolios beyond conventional investments. However, they come with some downsides, such as lower returns and liquidity. However, some categories of alternative investments may also provide high rewards while bearing higher risks. Investors must consider all these factors before choosing alternative investments.
One reason why investors may prefer investing in alternative investments is the low correlation with other investments. Most alternative investments do not behave similarly to conventional assets. Therefore, they provide better diversification for investors. Despite that, investors may have to bear some risks due to the lower demand for these investments.
What is Private Equity?
Private equity is a type of investment class that involves investing in unlisted companies. In other words, these include stocks from companies that do not trade on the stock market. Private equity usually includes companies in which investors can invest. However, finding such investments may be challenging due to the absence of a proper market for them.
Private equity may also involve investing in private equity funds. These funds, managed by private equity firms, allow investors to invest in private equity. In exchange, they charge investors with management and performance fees. There are further classifications of private equity, such as venture capital, leveraged buyouts, real estate private equity, etc. These provide investors with more options when seeking private equity investments.
Unlike other investments, casual investors may not have access to private equity. Usually, these investments are limited to institutional or accredited investors. Most private equity firms collect money from these investors and invest it in different private companies. Due to the higher risks involved, these investments are not available for most investors.
Is Private Equity an Alternative Investment?
As stated above, alternative investments include investments that do not fall in conventional investment categories. Private equity, meeting this definition, also constitutes an alternative investment for investors. Apart from these, several other characteristics emphasize why private equity is an alternative investment.
Private equity has a low correlation with conventional investments. Similarly, they usually have lower liquidity compared to other equity investments. Due to the absence of a primary market, determining the value of a private equity investment is challenging. Investors also have to bear high transaction costs on these investments. These are all characteristics that illustrate that private equity is an alternative investment.
Most investors prefer investing in conventional investment categories. However, some may also invest in alternative investments. These are investments that do not fall under the above categories. Private equity includes investing in companies that are not listed publicly. Private equity meets all the features of alternative investment.