What is an Alternative Investment?
“An alternative investment means an investment that is not one of the three traditional asset classes (stocks, bonds and cash),” according to Investopedia . Most alternative investments are held by institutional investors or accredited, high net worth individuals, because of their complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, and commodities and derivative contracts. Other features include high minimum investment requirements and fee structures compared to mutual funds and ETFs. Since they are subject to less regulation, it is often difficult to obtain immediate verifiable performance data on the investments.
Why do Investors Care?
Pension funds and private endowments invest in alternative classes, because they (1) have no correlation with the stock and bond market, (2) provide investment “class” diversification and (3) provide the prospect of yield enhancement to their overall investment portfolio. It is difficult to quantify the degree to which professional portfolio managers use alternative investments as a percentage of their overall portfolio, but it is not uncommon to find at least 10% of the portfolio in alternative investments, with no more than 5% in any one investment in that class.
Many of the characteristics of an alternative investment certainly apply to investment grade diamonds, since they have no correlation with the stock and bond markets, have high minimum investment requirements, are somewhat complex, are not regulated and have limited liquidity. The ability to verify pricing and performance data on diamonds has improved considerably, but is not easily available to investors outside the industry. Therefore, diamonds have the fundamentals of an investment class but, like other alternative investments, require professional guidance and specialized expertise.
Are Diamonds for Institutional Investors or Individuals?
One of the factors that prevent institutional investors from considering a meaningful investment in diamonds is the sheer magnitude of funds managed by institutions compared to the limited availability of larger investment grade diamonds. There is just not sufficient investment grade diamonds available in the market at any one time that would allow meaningful investment without driving up prices. Therefore, at least for now, it is an investment class for private investor groups and high net worth individuals that seek diversification of their investment portfolio.
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The Author: Paul Buchanan is a Graduate Gemologist, Graduate of the American Institute of Diamonds Cutting and has 30 years of experience in finance and traditional investment management. He is a diamond consultant advising investors on strategies for investing in diamonds.