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Fixed deposits (FDs), stocks, mutual funds, and gold are all popular investment options. However, several alternative investment possibilities have recently piqued the interest of investors. Hedge funds, private equity, commodities, real estate, venture capital, private debt placement, peer-to-peer lending, investing in start-ups, arts, antiques, vintage coins, stamps, inventory finance, and so on are examples of alternative investments.
Many investors, particularly high-net-worth individuals (HNIs), family offices, and some wealthy retirees, employ these instruments to create passive and recurring income.
Surprisingly, some items guarantee 11-13% returns. Such yields are very enticing, especially when compared to standard debt products, which offer 5-7% returns. Furthermore, the majority of alternative investments are unrelated to the stock or bond markets. As a result, they assist you in expanding your investment portfolio beyond standard market-linked products.
In this article, we will look at four different types of investments. And investigate how these investing alternatives function, the dangers they entail, and the potential returns.
The principle of peer-to-peer lending is quite similar to how a bank works. In a classic arrangement, the bank maintains the difference between interest paid and interest earned.
The bank also establishes several rules, terms, and conditions about who can borrow, how much can be borrowed, how much interest can be paid, and so on. Modern P2P lending platforms have been created by removing the need for banks from the equation.
As a result, lenders or investors might receive higher interest rates on their funds. Borrowers can also obtain financing through customized approval procedures.
P2P lending services such as Faircent, Lendbox, LiquiLoans, and RupeeCircle, in essence, serve as facilitators and risk mitigators.
Throughout the process, they offer a variety of services such as onboarding, credit evaluation, agreement signing, loan distribution, and collection services.
Lenders can now choose borrowers based on their preferred profile, loan purpose, and tenor. Their desired interest rate is between 12 and 35%.
Understandably, giving money to anyone is never without danger, and there is always the possibility of default.
Traditionally, real estate investing involves capital ranging from a few lakhs to a few crores. However, platforms such as Strata, PropShare, and others have enabled retail investors to buy commercial real estate in lower proportions.
The fractional ownership platform identifies an investable Grade A property, such as a commercial building or a warehouse, to begin the business model. The majority of the listed properties have current tenants on long-term contracts, resulting in cash flow visibility.
Now, because owning such a property would cost a few crores, the portal invites investors to pool funds to finance the asset’s acquisition. The minimum investment for investors is Rs 10 lakh. However, it may alter depending on the platform.
The platform forms a special purpose vehicle (SPV) to acquire the property after pooling funds from different investors. And the investor now owns stock in the company.
Annual asset management fees for fractional ownership corporations are typically around 1%. They also receive a percentage of profits above a certain threshold.
From the standpoint of an investor, the owner receives a monthly rental income with built-in rent escalation, just like any other real estate. Furthermore, the investor profits from the price appreciation of these assets over time.
As a result, fractional ownership platforms advertise rental rates of 8-9%, which is greater than traditional real estate’s yields of 2-6%. Furthermore, when property value appreciation is taken into account, these offers appear to aim for a pre-tax average annual return of 12-15% over a 5-year period.
REITs and fractional real estate have some parallels. For example, they both enable investors to purchase a portion of luxury commercial properties. However, they are not the same in terms of the dangers they entail or the profits they might provide.
Unlike REITs, fractional real estate investments are not SEBI-monitored and do not have strict asset diversification and distribution rules.
For the previous two years, FD returns have struggled to keep pace with inflation. But that is changing. We are seeing an increase in the number of start-ups that sell bonds, structured debt, and other high-yielding fixed-income securities to retail investors.
They intend to make a dent in the 1.5 trillion dollars foreign exchange market by issuing high-yielding debt securities. They not only offer greater interest rates, but they also allow investors to deposit as little as Rs 10,000.
Wint Wealth, BondsKart, AltiFi, and other platforms provide government bonds, AAA-rated papers, high-yielding BBB-rated corporate bonds, private bond placements, and structured debt. As a result, investors can select from a wide range of products, returns, credit protections, and liquidity.
Though all of these products are complex, some of them can be challenging if investors continue to focus their investment decisions just on the yield offered.
As an example, certain platforms provide a product known as senior secured bonds. There are two important keywords here: senior and secure.
The term “senior” refers to bondholders who have first priority in terms of repayment of principal and interest in the event of a default.
Another word for these bonds is secured,’ which indicates they are backed by collateral such as a pool of personal loans, gold loans, and so on. This is equivalent to creating another layer of defense.
Even if the platform delivers a BBB-rated bond, the senior and secured clauses help to improve the product’s creditworthiness.
For example, Wint Wealth recently closed a Rs. 25 crore issue of Quadrillion Finance’s BBB+ rated senior secured bonds.
This issue provided a pre-tax average annual return of 11.5% for a one-year bond term. As a safeguard, these unlisted bonds were issued against the collateral of salaried individuals’ personal loans.
The payment was designed in such a way that 33% of the principal, plus interest, would be reimbursed every four months.
This, however, does not rule out the possibility of the bond issuer defaulting.
Some safeguards followed by a tasty yield that normally runs from 9-11% tip the scales in favor of the investor.
Typically, there is a time lag between a vendor giving goods or services and the price he receives at the end. Vendors engage a bank or a financial institution to effectively handle cash flows during this period. The bank then buys these receivables at a discount in exchange for cash upfront.
Many sites, such as KredX, Jiraaf, TradeCred, and others, have omitted the banking connection. They connect vendors and investors that want to take advantage of this lucrative potential.
Invoices can now be in the millions or even crores. These platforms divide an invoice into digestible chunks, allowing investors to purchase a portion of the unpaid invoice amount. The minimum investment amount varies from deal to deal. However, in rare circumstances, transactions begin at Rs 50,000 or higher.
These changes typically have a short duration of 30 to 90 days, with a pre-tax average annual return of up to 15%.
From a risk standpoint, it all boils down to the entity making the payment to the vendor’s reputation. And the investor has effectively purchased a portion of the invoice.
If the paying entity fails, delays payment, or has delivery or legal concerns, it might substantially impede your returns and possibly your principal’s receivability.
The platforms that provide this service make every effort to verify the veracity of the raised invoice and the entity’s payment history, seek post-dated cheques, and may even need a personal guarantee from the promoter.
All of the alternative investments listed above are marketed as higher-return alternatives to fixed-income investing. They can also be viewed as diversification instruments, given they have a low correlation with traditional asset classes such as stocks, bonds, and gold.\
Some seemingly basic products are being provided additional layers of credit protection and security in order to improve the instruments’ risk-adjusted returns. While this works in most cases, you should be aware of the hazards associated with these products.
Most of these platforms and structures, for example, have a short track record and may not have been stress-tested sufficiently. Second, there is the ever-present credit risk, particularly when dealing with lower-rated papers and when a solution requires the participation of numerous parties. Third, there is a liquidity issue because there is no active secondary market for alternative assets.
Finally, there is a lack of regulatory oversight, which may be a major issue when things go wrong. So, these are some of the dangers that every investor should be aware of.
These investment solutions should not be considered as replacements for bank fixed deposits or debt mutual funds. If you want to dip your toes in these waters, you should limit your exposure to no more than 10% of your fixed-income portfolio.