Alternative Investments: Still the Road to Riches?

alternative investments

Private equity, venture capital, and hedge funds have been the rave lately. I check the WSJ and every day there seems to be a new investor that has made millions. However, does it make sense for the average investor to dabble in these potentially risky, yet also potentially very profitable investments?

 

 

Some definitions:

Private equity – private equity is exactly what it sounds like, a private investment of equity as opposed to debt. Basically, when you invest in the S&P 500 you are investing in public markets, and if you go buy an entire private company, then you are investing in private equity. Private equity became very popular in the 1980s when “corporate raiders” as they were called, started buying private companies with investor capital and making huge returns, like 4x an investment in 2-3 years or 10-20x in 10 years!

Venture capital – with Venture capital you’re primarily looking at technology and healthcare firms because there are many high growth startups in these industries. Venture capital is considered very risky because there are so many things that can go wrong at the early phases of growth in a company. In fact, most venture capital investments fail, but a few end up making 1000x for their investors, not too bad if you pick right!

Hedge funds – Hedge funds consist of investment professional with various strategies that aim to create alpha, which in basic terms means beating the average market with their investments. Many hedge fund managers make a great return, and you’ll see a few of them make 10s or 100s of million per year. This is because they keep 20% of all returns they make for investors, so do the math if you make a billion dollars for your investors!

Who do these investments make sense for?

Well first of all, the question should be, who is allowed to invest in these areas, and the true answer is, not many people. Most of these funds only invest capital on behalf of pension and endowment funds who have billions of dollars that need to be invested. Additionally, if you are an individual investor, in order to invest in these funds you usually need to be an accredited investor. Accredited investors are legally defined by the U.S government as someone who has a $1,000,000 net worth (excluding their personal residence), or someone with income of $200,000 or higher. Further, many of these funds will not allow you to invest less than $1,000,000!

What kind of returns can a limited investor make?

Well this varies for each asset class, and is heavily determinant on the success of you portfolio manager, but in general the following is true. In private equity a healthy return is around 20-25% per year over a 10 year period, so over 2x initial investment. In venture capital, the returns are usually negative until one company IPO’s and you make 1000x your investment. (if that ever happens) Hedge funds are somewhere in between these two, and have lagged the market overall in recent years, but certain hedge funds have performed extremely well.

I am not an accredited investor, how can I get involved?

Crowd funding has been growing in the new century, but usually only makes sense for real estate investments. Recall that most of these alternative investment firms are very successful firms and extremely intelligent, and are usually very selective in their client base as well.

If nothing else, this article hopefully motivates you to take action towards success, helps you understand that there is a lot of money to be made out there, and understand the basics of these alternative investment vehicles.

 

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