Alternative Investment Funds: Meaning, Types, Pros and Cons

Alternative investments refer to assets outside the mainstream categories of investing, such as stocks, bonds, and cash. They open up a whole new world of opportunities for investors looking to diversify their portfolios and potentially generate higher returns. In recent years, alternative investments have steadily grown in popularity across the globe, especially in India, thanks to their high return potential coupled with diversification benefits. 

This chapter provides a comprehensive guide to alternative investment avenues in India - their meaning, different types available, pros and cons, tips for getting started, and more. Read on to expand your understanding of this emerging asset class.

Types of Alternative Investments 

An alternative investment is a large class of non-traditional asset classes, not related to such standard types as stocks, bonds, and cash equivalents. The most common types include:

• Real Estate 
• Private Equity (PE)
• Venture capital (VC)
• Hedge funds
• Managed futures
• Art, gems, antiques
• Structured products
• Commodities
• Carbon credits
• Cryptocurrencies 
• Peer-to-peer lending (P2P)

Simply put, if an asset does not fit into traditional investment classes, it is classified as an alternative investment. Despite the variations in the definition from one country to another, alternative assets generally have several common qualities, such as complexity, less liquidity to a varying degree, light regulations, and the presence of high net-worth individuals (HNIs) or institutional investors.

Types of Alternative Investment Avenues Available in India

Here is an overview of the major alternative asset classes witnessing rising participation from Indian investors:

• Real Estate

Real estate is one of the most prevalent alternative investments used over the ages to generate income and create wealth.

Investors can gain exposure to real estate in several ways:

• Rental properties: Investors can purchase residential, commercial, or industrial properties, which they subsequently lease to tenants and get a continuous rental income. Increased appreciation also can lead to higher returns.
• REITs: These trusts allow investors to diversify their real estate exposure without the necessity of purchasing physical properties. REITs are listed on major stock exchanges just like stocks.
• Real estate funds: These collective investment funds offer the opportunity to invest in real estate projects and partnerships with fellow accredited investors.
• Real estate crowdfunding: Instruments like Fundraise let the investors purchase shares of individual properties or asset portfolios with minimums of even ₹500.

Some of the advantages real estate offers investors include:

• Cash flow: Rental income may generate stable cash dividends for investors.
• Appreciation: Property value growth historically accumulates with time as the land becomes scarcer and the demand increases.
• Tangibility: Real estate ownership is based on physical assets and isn’t just a piece of paper.
• Inflation hedge: Rental and property prices tend to rise with consumer prices, offering protection from inflation.
• Leverage: Financing allows investors to buy bigger real estate assets with limited capital outlays.
• Diversification: The performance of real estate has low correlations with stocks and bonds.

There are also downsides to real estate investing that investors need to consider:

• Management: Properties are a management burden, requiring ongoing management and maintenance.
• Illiquidity: Real estate is not quick to sell; on average, it sells in 3-6 months.
• Financing risks: Leverage introduces risk as the loans have to be continually serviced and refinanced.
• Concentration: Concentration risks may relate to geography or tenants when only a few properties are utilised.
• Vacancies: In economic recessions, vacancies may increase, leading to lower rental revenue.

Real estate provides cash flow and appreciation over cycles and has returned around 10-12% per year on average. Real estate investing has become a low-barrier-to-entry sector that people with small upfront capital can access because of options like crowdfunding.

• Private Equity and Venture Capital

PE/VC investments involve providing capital to private companies not listed on stock exchanges. Investors receive ownership stakes in such companies and earn high returns through eventual exits via strategic sales or IPOs.

PE deals typically target more mature companies seeking capital for expansion/restructuring plans. The deal sizes range between USD 5-100 million.

VC investments focus on rapidly growing startups or small ventures aiming for a larger scale. Deal sizes here are much smaller - from a few hundred thousand dollars to USD 5 million.  

In India, sectors like technology, healthcare, energy, financial services, and consumer goods attract substantial PE/VC interests, given their high growth potential. Investments take place directly or through managed funds. Prominent players include Kalaari Capital, Sequoia, SAIF Partners, Nexus Ventures, etc.

PE/VC investments in India have surpassed USD 46 billion in 2018 - 2019, showcasing their rising prominence. With projected GDP growth rates above 6% and a flourishing startup ecosystem, this segment promises strong momentum. However, these are intricate investments requiring sharp assessment skills considering the execution risks involved. Reputable fund managers become vital for success here.   

• P2P Lending 

P2P lending represents a revolutionary concept, bringing borrowers and lenders together directly through online channels and marketplaces. It facilitates convenient lending and borrowing sans traditional intermediaries. 

For investors, these platforms offer fixed-income alternatives with returns often exceeding those from traditional fixed deposits or debt funds, along with low investment thresholds. Depending on underlying asset quality, returns differ on the Indian P2P lending platforms.   

Borrowers enjoy quicker access to credit through simplified application procedures and approval timeframes.   

P2P lending has witnessed remarkable traction lately, aided by technological advances and process innovations. India boasts over 30 established P2P startups like Faircent, Lendy, Liquiloans, i-Lend, LenDenClub etc. Loan volumes have ballooned from ₹52 crore to 1500+ Crores within 5 years, showcasing the potential.

With suitable risk mitigation and prudent platform selection, P2P lending promises attractive high-yield investment opportunities. Improvement in RBI guidelines and operating frameworks will boost industry maturity, too.

• Structured Products  

Structured products allow customised exposure to underlying asset classes like equity, debt, derivatives, etc., based on specific viewpoints. An issuing institution structures combinations of financial instruments to meet investors' varied return or risk objectives.  

For instance, a structured product can offer equity-linked returns but with capital protection. Another product may provide higher but capped gains if markets rally, else assured minimum gains. Such customisation allows aligning investments closer to changing needs.                 

Issuers are typically investment banks or large financial entities. Structured products carry credit risks similar to bonds or debentures. However, their uniqueness allows precise targeting of goals and distinguishes them from traditional instruments.

In India, distributors like HSBC, YES Bank, and Kotak issue equity, debt and hybrid structured products with returns linked to benchmarks like Nifty. Issues carry ratings indicating reliability. While awareness is limited, structured products should aid sophisticated portfolio management once their workings become familiar.  

• Gold and Other Precious Metals

Gold and other precious metals represent physical assets that closely follow demand-supply conditions, given that these are constantly traded and used around the world. Gold holds a special relevance in Indian culture and retains its sheen despite market volatility.

While commodities like these can be traded directly through authorised brokers, structured products have made them easily accessible to retail investors. These include ETFs (exchange-traded funds) like Gold ETFs, Sovereign Gold Bonds, e-Gold units, etc., allowing small-value purchases and seamless trading. 

With strong inflation-beating potential and minimal correlation to traditional assets, gold and other precious metals help balance overall portfolio risk dynamics. 

With constant demand and equity market fluctuations, metals like gold investments can be safer. 

• Other Niche Alternatives

Many other exotic alternatives target HNIs and institutional players:

• Collectibles - Art, antiques, coins, wine etc.
• Hedge funds - Aggressively managed portfolios, complex strategies
• Managed futures - Speculating on futures contract movements
• Carbon credits - Transferable certificates reducing carbon emissions  

Such investments cater to ultra-niche segments only, given their complexity. Extremely rigorous evaluation is vital while participating.

Pros and Cons of Alternative Investments

Alternative investments offer a range of benefits but also pose their own unique risks, as highlighted below:  

Pros	Cons
Potentially higher returns	Complex risk-return dynamics
Effective diversification	Lower liquidity
Inflation hedges	Limited transparency
Wider asset choices	Higher costs
Resilience to market shocks	Need expert guidance

Alternative Investments Landscape in India

Several factors underpin recent prominence acquired by alternative investment avenues in India:

1. Potential for Higher Returns: The non-conventional character of alternative assets offers ample room for elevated return that frequently exceeds those yielded by traditional investments. For example, in the life sciences and healthcare sector, a return of 22-25% in the last five years has been achieved by PE/VC investments in India.
2. Diversification Benefits: Alternative investments usually exhibit low correlations with traditional assets, enabling efficient portfolio diversification and risk allocation. Their returns defy the dominance of the equities’ market cycles.
3. Wider Choice: Investors today have access to a much broader alternative investment spectrum - from relatively simple options like P2P lending to sophisticated instruments like hedge funds - catering to varying risk appetites.
4. Increasing Institutional Interests: Domestic HNIs and family offices are showing a greater inclination towards alternative assets. More asset managers and advisors now offer customised alternative investment solutions, too. 
5. Regulatory Support: Gradual policy-level changes are facilitating wider alternative investment participation. Take private real estate investments, for instance - improved transparency and structure have resulted in remarkable capital inflows lately.   
6. Inflation Hedge: Certain alternatives like real estate or gold prove effective in combatting rising inflation levels by preserving or boosting investors' purchasing power during such scenarios.

Tips for Getting Started

Here are some handy pointers while embarking on your alternative investment journey:

• Gain an overall perspective of assets – risk and return potential
• Define personal investment objectives – return targets, liquidity requirements and horizons.
• Consult with professionals – agents, investment advisors, and portfolio managers.
• Begin with small investments  - Increase your risk tolerance with small investments before making large ones.
• Invest monthly - SIPs can help smoothen the paths.
• Balance with conventional investments to maximise stability.
• Monitor the portfolio periodically and adjust it in response to changing circumstances and new opportunities.

Conclusion

Even though alternative investments are considered less developed in India by global standards, they hold interesting prospects if we consider the economic environment. However, moderate exposure is recommended now due to the infancy. As the platforms standardise and the markets deepen, the opportunity will open up even more.

All in all, alternative investments give an interesting set of instruments, enabling investors to broaden the investment horizon beyond conventional options and improve the diversification of the portfolio. The above guide addresses their diverse aspects in an integrated way. For investors who are willing to go beyond traditional choices, the alternative world provides real ways to help increase portfolio performance to the next level while still managing risk. The avenues are poised to thrive as long as due diligence in risk assessment and monitoring is not sacrificed.

Moving forward, in upcoming chapters, we’ll look at a few different alternative investments in detail.