What Are Alternative Investments?

Alternative investments are high-risk investment vehicles that offer an alternative to traditional investments, like stocks and bonds. Like all risky investments, alternative products come with the chance for higher returns than a blue-chip stock or a conservative index fund. The key word is “chance.” They also run the risk of losing significant amounts of money.

Alternative investments’ performance does not correlate with the stock market, which leads many investors to conclude they are a good source of diversification. However, it is questionable if diversification is worth the risk. Recently, the securities market has seen a rise in alternative investments aimed at ordinary investors, rather than wealthy investors who could afford to risk a small portion of their portfolio for larger returns. Michael Fine, a professor of wealth management at the American College of Financial Services, told The Wall Street Journal: “[Alternative investments] are often too pricey from a risk-reward standpoint,” and that the “comparative value of many alternative products in the long run is debatable.”

Alternative Investments and FINRA Rule 2111

Unfortunately, many brokers or investment advisors have solicited clients to invest in alternative investments by highlighting the possible returns, without underlining the likelihood of losses. According to FINRA Rule 2111, brokers are required to recommend investments that fit an investor’s financial goals and risk tolerance. For example, investors who want to rely on their securities portfolio for retirement income should select conservative investments. If a broker recommended an unsuitable investment, investors may be able to recover their losses by holding the brokerage firm accountable and pursuing FINRA arbitration.

If you are not an accredited investor–typically an investor with a net worth of over $ 1 million–then alternative investments probably will not suit your investing needs.

Risks Associated with Alternative Investments

There are a number of risks to consider before investing in alternative investments. Some of those risks are outlined below. 

Difficult to Sell. Because they do not register with the SEC, investors cannot sell alternative investments on the stock exchange.

Fees. Because alternative investments are more complex, they require more active management. As a result, they come with steeper fees than ordinary investments.

Lack of Regulation/ Information. Alternative investments do not have to register with the SEC, meaning they do not have to disclose information about their financials and operations. This information is crucial to assess an investment’s potential performance.

Higher Minimum Investments. Because these investments are higher risk, they are meant for wealthier investors. Typical minimums range from $10,000 to $50,000.

Illiquid. Investors are expected to keep their money in the alternative investment for a long period. If an investor wants to get their money out before the maturity date, they may face a high fee.

Complex Strategies. Investors should ask questions about how their alternative investment works, and how they can measure success.

Types of Alternative Investment Funds

Hedge funds may choose to invest in alternative investments, but these types of investments are only available to exceptionally affluent investors. Alternative investments may also be part of an exchange-traded fund (ETF), a mutual fund, or a private equity fund.

Here are a few common types of alternative investments:

• Private Equity investments give the investor a stake in a privately owned company. These types of investments often provide venture capital to start-ups.
• Private Credit, or Private Debt alternative investments allows investors to lend money to a private company. If the borrower defaults, a senior lender may be entitled to recover assets like real estate.
• Commodities are tangible goods for sale, like fine wine or works of art. Unless you are an expert in these types of investments, it is difficult to know if they will appreciate over time. These alternative investments may involve futures, which are a type of investment that places a bet on the future price of a commodity. Alternative commodity investments invest in natural resources like oil.
• Non-Traded REITs are a common example of an alternative asset in real estate. These are investment companies that invest in income-producing real estate, like hotels or office space.

Alternative Investment Examples

The following alternative investment examples illustrate the risk associated with alternative investments.

• Investment fund Tiger Global lost $17 billion after pouring billions of dollars into tech startups, as part of its private equity alternative investment strategy. Tech stock prices crashed in 2020, triggering staggering losses.
• New York City REIT is a non-traded REIT that suffered huge losses following the pandemic – losses that stemmed from its concentrated position in office space real estate.
• GWG L Bonds are a type of bond that uses investor capital to purchase life insurance policies. When these life insurance bonds did not perform as expected, the company allegedly relied on new investments to pay previous investors. Because of this structure, some securities attorneys allege it functioned as a Ponzi scheme.
• Business Development Companies (BDCs) loan money to struggling small to medium-sized companies. They may use borrowed money to fund these loans, making them especially risky. Non-traded BDCs lend money to companies in especially dire straits, making default especially likely.

What Should I Do If I Lost Money in an Alternative Investment?

If a broker recommends an alternative investment without explaining the risks, you may be able to recover your investments through FINRA arbitration. Speak to a securities lawyer if you believe your alternative investment did not fit your conservative investing goals. Contact our experienced legal team at info@kurtalawfirm.com or (877) 600-0098.