Alternative investments are some of most complicated and difficult to navigate investments available. They usually take on higher-than-average risk in return for the potential of higher-than-average returns. Due to their complex nature, alternative investments are meant for very knowledgeable investors or for investors with a lot of money who can afford to take higher risks or get specialized advice.
Here are some examples of alternative investments:
An option, a form of a derivative contract, provides an investor the right to buy or sell a specific asset for a set price during a set period of time.
A call option gives an investor the right to buy a specific asset at a determined price during a set period of time. A put option gives the investor the right to sell a specific asset at a determined price during a set period of time. This asset could be a stock, a commodity a currency or an index.
Options do not pay dividends or interest. Any money that is gained, or lost, is dependent on the asset’s market value during the specified time period.
An income trust is a trust that is designed to distribute cash to investors. The most common type of trusts are real estate investment trusts (REITs), oil and gas income trusts and business income trusts.
Trusts generally try to pay the same amount of returns to their investors each quarter, but they can be changed or stopped entirely at any time. Returns typically depend on the profits the trust makes from the assets it holds and any tax benefits that may be available to investors.
Risk to investors in an income trust is dependent on the type and performance of the assets held by the trust. Similar to investing in common shares, trust investors are not insured against investment losses.
Like a mutual fund, a hedge fund pools money from many investors and is managed by a fund manager. However, a hedge fund offers more flexibility to the fund manager, allowing the use of advanced investment strategies. These advanced strategies are not usually permitted in mutual funds and include things such as leverage, long and short positions, and derivatives. These advanced strategies bring with them increased risk, but also the potential for higher returns.
Hedge funds are typically bought by investors with large amounts of money, which gives them the ability to withstand the significantly higher risk involved. Due to the aggressive investment strategies involved with managing a hedge fund the fund manager will typically need to do more research and have constant monitoring of the fund. They will also likely do more trades than a normal mutual fund leading to higher operating costs and in-turn higher management fees for those invested in the fund. Fund managers may also participate in any gains attributed to the hedge fund in addition to management fees.