The Basics of Alternative Investments
With a skyrocketing inflation rate and depreciation of the naira, these are not exciting times for Nigerians. It has now become necessary for investors to diversify to bridge the negative real returns.
Outside the familiar world of stocks, bonds, mutual funds and treasury bills, there is a whole universe of investment vehicles that can help investors in Nigeria achieve the diversification that they so much crave. They are called Alternative Investments.
What are they and how do they work? This was the subject of our conversation on #AfrinvestTalks with renowned Investment Research & Securities Trader, Ayodeji Ebo.
What are alternative investments?
Alternative investments are simply investments that don’t fall into the typical categories of investments that we are used to seeing. By typical, we mean Equities, Bonds, Treasury bills, etc. They have more complex investment structures than the traditional kinds, and require proper understanding from investors who understand the dynamics and associated risks, just like any other kind of investment.
What are some of these kinds of investments?
We have quite a number of them, for example, we have Real Estate, Commodities, such as Agriculture, Metals, Insurance Products, Derivatives, and so on.
Real Estate Investment is beyond the traditional buying and selling of lands and buildings and has become more easily accessible through the form of Real Estate Investment Trusts (or REITs). A Real Estate Investment Trust works very similarly to Mutual Funds, where capital is pooled from many investors. However, the goal is to invest in companies that manage and finance income-generating real-estate such as rentals and commercial buildings.
The advantage of a real estate trust is the potential to earn income in the form of a dividend, without buying and managing any physical property. This makes it quite easy to invest in them and while not all REITs are publicly traded, there are several REITs listed on the Nigerian Stock Exchange (NSE).
We have three REITs currently listed on the NSE — SFS, Union Homes, and UPDC REITs. Individuals can go through their brokers/asset managers to invest in structured products. REITs are also available on the NSE. AFEX Nigeria also has a platform to trade commodities.
Another advantage of Real Estate investment is that they offer a stable source of income and are a great way to diversify one’s portfolio. At the moment, REITs will give you an average of about 7% for REITs. Also bear in mind that the risk profile for REITs is High.
What is Commodity Trading?
First of all, we know Commodities are basic raw materials or agricultural products. So, Commodities Trading is the buying and selling of these products.
For Commodities, for instance, one can trade Agriculture related commodities directly on the AFEX Commodities Exchange while New Gold ETF on the NSE. Future contracts can also be traded on the AFEX Commodities Exchange.
Futures are a more standardized way of predicting the future price of a commodity by locking it in at today’s price. For example, if an investor thinks the demand for soybeans is going to increase in the future, he can choose to enter a futures contract at today’s price for future delivery date.
The most common kind of commodities is Agricultural products. While there are some popular ways of investing in agriculture, such as crowdfunding and directly trading on the commodities exchange, we also have specialized products structured by Asset Managers which are offered to investors.
Crowdfunding for agricultural investments
The main thing with crowdfunding is that investors have to do further research on the specific investment. We have to always remember that risk and returns often move in the same direction. That is, higher returns are usually indicative of higher risk factors.
Investors also have to consider the insurance policies surrounding their investments. That is, not just knowing that their investments are insured, but the extent to which the total investment is insured and the insurer. It’s quite the norm for the extent of insurance to be mainly on the principal and not extended to the interest.
For now, we are yet to have a standardized regulation for Agric investments, but the Securities and Exchange Commission (SEC) has proposed rules on crowdfunding. The rules will see the registration of crowdfunding portals and issuers to protect investors.
What about Cryptocurrency?
Cryptocurrency is the same thing as virtual currency. This is because they are designed to serve as a medium of exchange whereby its ownership is stored across decentralized networks or blockchain technology. Although the most popular kinds of cryptos were initially Bitcoins and Etherum, there are now numerous cryptos out there and it has now become very popular in Nigeria.
The major thing to note about cryptos is that they work very similarly to commodities, in that they are traded solely on the forces of demand and supply. This means that, unlike traditional investments, they do not yield any form of interest or dividend payments. This can be quite risky when you take into consideration the fact that the market is largely unregulated and volatile, so, an investor’s capital is unsecured.
Also, because there are numerous cryptos out there, beyond the very popular virtual currencies we know, an investor has to be cautious with the kinds of cryptos they invest in. This is because losses or gains will be hinged on the demand of the specific cryptos being invested in. So, less popular cryptos may likely yield less since it’ll be in less demand. This may also mean that these less popular cryptos may be more difficult to liquidate.
Do FX Forward Contracts qualify as an alternative investment?
No. FX Forward Contracts are mostly used for hedging existing investments and not an alternative investment.
Common myths about Alternative Investments
You need a lot of funds to get involved in these kinds of investments. That’s not true. Currently, more easily accessible alternatives have been created in such a way you do not necessarily have to buy the physical products but still, play in the market and make income. Discussing with your Broker or Asset Manager will provide you with the ways that will work for you specifically in the market.
A final word for investors
While it is important to consider inflation when assessing an investment option, it’s also very important to remember that returns are always determined by the risk level of the assets. This makes it necessary for investors to understand the type of investment they get involved in and the dynamics of the market they are playing in and by extension, this will help the investor to have practical expectations on the performance of their assets.
#AfrinvestTalks is an interactive twitter chat that focuses on breaking down complex investment concepts with the goal of developing a community of avid investors. Follow Afrinvest on Twitter to join the conversation.