By TODD KOCKELMAN
If you’re seeking a different investment path and have a large amount of money to invest, you may already be considering an alternative investment. Alternative investments sidestep the traditional investment paradigm, such as real estate, cash, stocks, and bonds; they seek a greater return from a more complex (and, it must be said, riskier) set of circumstances.
Here is a brief overview of some investment options within a vast and complex financial arena.
Hedge funds, private equity funds and venture capital funds, distant cousins of mutual funds are not for the average investor and offer the possibility of superb returns at considerable risk. Generally speaking, it takes a lot of money to get into one of these funds and they are not for the skittish. 1,2
Direct participation oil and gas investments can produce great returns, or miserable ones – depending on the temperament of the energy markets. Oil and gas investment programs often have high minimums, and navigating these programs requires a veteran eye.
Timber REITs (real estate investment trusts) allow the small investor to participate in this asset class. Timber has historically had very low correlation with the stock, bond, and commercial real estate markets and inflation.3,4
Real estate investment trusts (REITs) can be private or publicly traded and allow the small investor a way to participate in the commercial real estate sector without the burden of property management. REITs must pay out about 90 percent of their annual income, so they are encouraged to pay high dividends to unitholders. The drawback is that the IRS regards that annual dividend as taxable income.5,6
Options contracts give the holder an option to buy (a call) or sell (a put) a specific amount of a stock, ETF, currency, debt instrument or commodity at a specific price within a specific period of time. High net worth investors consider option contracts because of the potential income from covered calls, the possibility of locking in some profits as a consequence of buying puts, the chance to hedge by selling covered calls and buying puts simultaneously, and the opportunity for added portfolio diversification. Long Term Equity Anticipation Securities (LEAPS) are long-term options contracts (commonly 2-year options).
Retail futures traders try to speculate on price movements of all manner of commodities and even gauges of volatility. A small investment of thousands of dollars may allow an investor to control a futures contract worth many times more, so the leverage is really significant. But losses can be significant, too.
E-mini futures are smaller versions of larger futures contracts. They generally have a lower minimum than standard futures contracts, but are also potentially subject to the well-publicized shocks of electronic trading rather than the action in the old-school trading pit.
Investing in managed futures means selecting a rigorously regulated professional money manager – a commodity trading advisor, or (CTA) – that invests in commodity, currency and even equity index futures on your behalf. Most CTAs do this through proprietary trading systems. It generally takes $50,000 or more (sometimes much more) to invest in a managed futures account. As this is commodities trading, substantial and sudden losses may occur, as well as substantial and sudden gains.7
Also known as inflation-indexed securities, real-return securities are typically notes or bonds with coupon payments linked to inflation rates. The issuer guarantees that the security’s return will outperform inflation if the security is held to maturity.8
Cautious investors have looked into market-neutral funds, which are sometimes called long-short funds. Their money managers commonly work with a goal of buying call options to capture some upside and buying put options and derivatives to hedge on the downside. Unsurprisingly, some of your potential for gains may be tempered as a result, and returns may be underwhelming when the bulls are running.9
Global macro funds are actually hedge funds that seek to take positions in the markets according to macroeconomic principles.
Business development companies (BDCs) are cousins to venture capital funds. BDCs have to invest 70 percent of their assets in private or public corporations and pay out 90 percent or more of their taxable income as dividends. 10
Mutual funds and ETFs that invest in foreign currencies gain allure when the dollar weakens. Currency funds are run by an investment manager and employ some tactics of hedge funds, yet are available to the small retail investor.
By acquiring seasoned knowledge of supply and demand forces and trends in the coin, stamp, art and hobby collectible markets, profit can be made far from Wall Street; it may take years of insight (and great instincts) to truly come out ahead.
Who can explore these "alternatives?" Those who meet account minimums are eligible to invest in managed futures and some other forms of alternative investments thanks to niche mutual funds, REITs and ETFs. However, in many cases individuals and investment companies have to meet strict criteria demanding proof of assets in the millions and/or income in the hundreds of thousands to qualify.
This is an overview. Anyone wishing to enter the alternative investment arena should speak with financial, legal and tax professionals familiar with its nuances.
Todd Kockelman, president of K-F Financial, is a registered representative with Packerland Brokerage Services Inc., and can be reached at 651-204-0655 or Todd@K-Ffinancial.com.
2 – www.bls.gov/news.release/pdf/cpi.pdf [4/13/12]
3 – www.chicagotribune.com/business/sns-201203141400–tms–retiresmctnrs-a20120314mar14,0,1100086.story [3/14/12]
9 – blogs.reuters.com/reuters-money/2011/04/11/why-market-neutral-funds-may-come-up-short/ [4/11/11]
10 – www.dividenddetective.com/all_about_BDCs.htm [4/21/12]