When it comes to investment, most individuals go for the conventional asset classes like stocks, bonds, etc. Besides the traditional asset classes of investment, there is an entirely different category of investment instruments called alternative investments.

As the name suggests, alternative investment tools are an alternative to the traditional tools of investment.

Multiple types of investment instruments are grouped under alternative investments. Each one of them has different characteristics and can have a different effect on the portfolio if included.

Common Types of Alternative Investments in South Africa

• Real Estate

Real estate investment is the most common form of alternative investment globally. This includes investment in residential, commercial, farmlands, and timberland real estate. The prices and volatility in prices of real estate depend on the size, locality, fertility, reachability, and several other factors.

Real estate investments have historically proven to be less risky than any other investment avenue. The prices of real estate generally go up in long term.
The only factors that limit common individuals from real estate investment are liquidity and the amount required for investment. Real estate properties are generally expensive and cannot be afforded by every retail investor. The average real estate price in South Africa is nearly R1,500,000 which has grown by more than 9% annually in the last few years.

Each seller can have a different pricing strategy for the properties. Income capitalization, discounted cash flows, and sales comparable are the common methods of real estate valuation.

• Commodities

Commodities are basic goods that are used as raw materials or inputs in the production of other goods or services. Metals, Oil, Natural Gas, grains, livestock, etc are examples of commodities. These goods are of similar pre-set quality and are interchangeable with other goods of the same type. The prices of each commodity mainly depend on supply and demand but can also be affected by rainfall, technology, trades, economy, etc.

Gold is the most common commodity that is used for investment and trading worldwide. Commodities are tangible assets but investment in commodities may or may not require the investors to hold physical assets. Most of the commodity investment and trading in South Africa is done through electronic technologies.
In South Africa, there are 3 methods to invest and trade in commodities. The first method is to simply buy and speculate physical commodities.

The second method is to trade commodities is through futures and options via the JSE commodity derivatives market. The settlement is mostly done in cash but can also be physical (exchanging actual commodities).

The third method to trade commodities is through CFDs. This can be done via FSCA regulated CFD brokers in South Africa. Only the prices of the underlying asset are speculated in the short term with no involvement of physical assets. Many CFD brokers offer online trading apps for South African traders where you can trade Forex and Commodities.

• Collectibles

Collectibles can include any physical item that is rare and whose value can increase over time. The collectible items can be vintage cars, rare wines, renowned trophies, antique guns, etc. There is no predetermined method to value the collectibles but the experts of concerned fields can derive the approximate values. In most cases, the seller decides the indefinite prices of collectibles.

Items need to be preserved carefully and can also incur a cost of preserving. These items generate no income until sold. This type of alternative investment may not be ideal for every investor.

• Derivatives

Derivatives are contracts between two parties to buy or sell the underlying asset with predefined spot price and expiry. Futures and options are the most common derivative instruments available for retail investors in South Africa. These are traded on Johannesburg Stock Exchange’s Derivatives Marketand have high liquidity with negligible third-party risk. While forwards and swaps are traded over the counter with independent parties and can have third-party risk. The underlying asset for any derivative contract can be equity, bonds, indices, commodities, currency, interest rates, etc. F&O derivatives on JSE are traded through its authorized trading members.

CFDs are also derivative instruments as their value is derived according to the pricing of underlying instruments. The trading volume of CFDs in South Africa has increased dramatically in the last few years. CFDs brokers are regulated and licensed by FSCA in SA. There are 7common types of CFD instruments offered by CFD brokers which include CFDs on Commodities, Energy, Metals,Indices, ETFs, Shares andForex Trading.

• Private Equity

Investment in equity of businesses and companies that are not listed on any public stock exchange is broadly called private equity investments. There are multiple forms of private equity investments in South Africa. The term private refers that this investment is unregulated is done according to agreed-upon conditions between investor and business.

Venture Capital (VC) investment is a type of private equity investment done in start-ups and businesses in their initial phase. The investor gets an agreed-upon percentage of ownership in the equity of the business in return.
Growth capital investment work similarly but the businesses are at a mature stage. This investment helps the businesses to expand further while the investor gets shares of equity in return.

The buyout investment is a private equity investment in which the whole ownership of the business is transferred to the investor. This type of investment is commonly done by corporates.

• Private Debt

Private debt investment is similar to fixed income investment in bonds and debt instruments. The major difference is these investments are not financed by banks or any other non-banking financial company.

The issuers of private debt can offer different interest rates and coupon payments at regular intervals. These debt investments are offered by debt funds or private debt service providers. Public and private corporations that require additional capital can also offer private debt in the form of corporate bonds. Each private debt has different credit quality depending on third-party risk and interest rates.

• Hedge Funds

Hedge funds are managed by professional fund managers who aim to increase the valuation of the fund. The manager can trade different liquid assets and use varying objective-oriented strategies for capital appreciation. Hedge funds in South Africa are generally only limited to institutional investors.

• Structured Products

Structured products are a complex type of alternative investment. This investment tool includes a pre-packaged combination of one or more asset classes that are linked with one or more derivative tools like options and futures.

Each structured product can have a different risk factor and return generating ability. Some products can also have negligible risk as the principal amount invested on the asset can be secured by a derivative contract. It is a modern alternative investment that can be complex to grasp for beginners but can be a great alternative to traditional investment tools.

• Cryptocurrencies

Cryptocurrencies are digital currency that has no physical presence and only exist electronically. It is a collection of binary data that is decentralized and designed for the medium of exchange. Each ownership and transaction details are stored in a ledger that is protected by cryptography.

Bitcoin and Ethereum are the most traded cryptocurrencies but more than 1000 cryptocurrencies have evolved till date. Cryptocurrencies have shown dramatic and remarkable price gains since their introduction in 2011. Cryptocurrency investment can be done through any cryptocurrency wallet provider or via CFD or Forex brokers in South Africa. Cryptocurrencies are currently unregulated in SA.

Benefits and Limitations of Investing in Alternative Assets

Alternative investment tools just like traditional investment tools have different risk to reward ratios. There can be added benefits of investing in alternative instruments but one must also understand the risk factors before indulging in the alternative investment world.

• Low Correlation with Traditional Instruments

The price movement insome traditional investment tools does not have a significant impact on the prices of alternative investment tools. This helps in diversifying the investment portfolio which mitigates the overall risk in the portfolio.

• Counterweight to Conventional Assets

Most traditional investment tools can only be bought for price speculation. The investor earns profit only when the prices move upwards. With the alternative investment tools, the investor can also go short and hedge the downside risk in the portfolio.

• Offers Diversification

It can offer diversification for investors looking for mix of assets and investments than their tradition portfolio.

• Hedge against Inflation

Alternate assets can offer hedge against inflation. As assets like Gold and Real Estate have seen steady growth since last 3 decades. Gold is often seen as hedge against inflation and store of value by professional investors.

• Difficult to Determine Value

Many alternative investment tools are not traded on a regulated exchange. The pricing and valuation can be too vague to determine for the retail investor. Prices of instruments like collectibles, real estate, private equity & debt, etc. are determined by the seller. The knowledge, experience, and expertise of the instrument can assist in price discovery but this price may not be the same for every investor.

• Lower Liquidity

Instruments that are not traded on any exchange or market are hard to liquidate. Once you own the alternative investment assets like collectibles, real estate, private equity, etc., you cannot convert them back to cash during an emergency. The liquidity risk is a major risk factor in most of the alternative investment tools.

• High Entry Level Cost and Exclusive Availability

Many alternative investment instruments require a substantial investment amount. Investment in collectibles, real estate, private equity, etc cannot be afforded by every retail investor. Most of these instruments are exclusively available for limited and institutional investors. This restricts many of the small-scale retail investors to take the advantage of alternative instruments.

• Lesser Regulation

Most Alternative investment tools except for futures & options (that regulated by JSE& FSCA) and CFDs (that are regulated by FSCA) are not regulated by any authority in South Africa. Lack of regulatory oversight further increases the third-party risk as each seller of the instrument can have independent conditions of investment.