Equity, bonds, and mutual funds are the best-known investment instruments. But there are several other instruments that you can invest in. They are collectively known as alternative investments.
In this section, we will discuss what are alternative investments and how to invest in some of the common alternative investments, namely exchange traded funds (ETFs), derivatives, commodities and private equity.
Exchange traded funds (ETFs)
An ETF is a special kind of mutual fund that trades like a stock and tracks the movement of an index, such as the Nifty or Sensex. ETFs only invest in stocks that make up the index they are tracking. For example, an ETF tracking the Nifty will only invest in the stocks that make up this index. You can buy and sell ETF units on the market, just like stocks. Since the ETF invests only in Nifty stocks, the price of its units will move according to the Nifty.
By knowing what are alternative investments and investing in ETFs, you can buy into the growth of an index as a whole, without individually investing in its stocks. Invest in ETFs if you have a hard time picking individual stocks or if you want to cut your trading costs. Some ETFs also track overseas indices, which gives you exposure to say US or European stocks. Like equity indices, there are also ETFs that invest in debt and gold. You can invest in gold ETFs if you want to invest in gold without buying physical gold.
One of the types of alternative investments are derivatives. These are contracts whose price depends upon (i.e. is derived from) the price of other assets, such as stocks, bonds, commodities, and currencies. You can buy and sell them on a derivatives exchange. They were traditionally used to mitigate (i.e. hedge) the risk of a sharp movement in the price of the underlying asset. But they are also popular as profit-making instruments.
There are major types of derivatives:
1. Futures – This is an agreement to buy or sell an underlying asset at a pre-decided price on a future date. Assume that you just bought a stock for Rs.100. You would make a profit if you sold it at a higher price later. But you would incur a loss if its price fell. You can mitigate this risk by buying a futures contract at say Rs.110. This would obligate you to sell the stock at Rs.110, irrespective of how its price changes. But it will ensure that you make a profit of Rs.10.
2. Options – These are similar to futures contracts, except that they give you an option instead of an obligation to buy or sell at a pre-decided price. The option to buy is called a Call option and the option to sell is called a Put option.
In the previous example, had you bought a Put option, you could have decided whether to sell your shares or not on the future date. If their price rose above Rs.110, you could have opted out of the contract and sold your shares in the open market at a higher price.
Any basic good that is used as raw material or input in the production of other goods or services is a commodity. Commodities can categorised into:
1. Metals – They are further categorized into base metals (like copper, tin, and zinc) and precious metals (like gold, silver, and platinum).
2. Energy – Crude oil, natural gas etc.
3. Agricultural commodities – corn, sugar, cotton, wheat etc.
4. Meat and Livestock – live cattle, lean hog, feeder cattle etc.
Commodity trades usually happen through the futures market. Commodity futures are contracts where the underlying asset is a commodity. They are mostly used for hedging by entities that deal in these commodities. For example, a cotton farmer may protect himself from a fall in the price of cotton by buying a cotton futures contract. However, you too can trade in commodity futures to profit from commodity price movements.
Private Equity (PE)
These are funds that invest in unlisted companies with strong growth potential. They have a high minimum investment threshold, which makes them viable only for high net worth individuals (HNIs). The manager of a PE fund is called general partner (GP). He also invests in the fund along with the other investors, who are called limited partners (LPs). In addition to investing the fund’s corpus and handling its administrative duties, the GP is responsible for defining how profits will be distributed among the LPs.
The aim of a PE fund is to build a portfolio of companies, just as you would build a portfolio of stocks. However, instead of buying a few shares, PE funds buy major stakes in these companies. At times, they also acquire whole companies. The idea is to bring together companies that can strategically benefit from each other by sharing their capabilities. Some of these funds are sector-specific. They only invest in one sector, such as IT or financial technology.
To sum up
The above-mentioned are some of the alternative investments in India. Including secure alternative investments and assets in your investment strategy is a good way to diversify. The price dynamics of commodities are very different from equity, bonds, and mutual funds. They are a high risk-high return asset class. Adding a small proportion of these can boost your portfolio returns, even if you are a low-risk investor.
Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.
All about Equity
What is equity fund?Equity or shares are instruments companies issue to raise funds for their growth. Investors buy these kinds of equity investment such as shares because they expect the value of these shares to increase as the company grows with the help of their funds.Equity shares give you ownership rights in the company. In other words, if you buy a company’s shares, you become one of its owners. However, your ownership interest is extremely small because you own a very small percentage of shares. Nonetheless, your shares give you the right to vote in all important matters of the company. They also entitle you to a share in the company’s profits. How to buy shares?There are two markets where you can buy shares – primary and secondary. The Primary market comprises all transactions in which the company directly (i.e. through an agent) offers its shares to general investors. The first time a company does so is called its initial public offer (IPO). All subsequent offers are called follow-on public offers (FPOs). You can bid for IPO and FPO shares through your demat account.A company’s shares get listed on a stock exchange soon after its IPO. From here on, you can buy and sell them on the stock market. All buy and sell transactions on the stock market are called secondary market transactions. Exchanges act as an intermediary between the buyer and the seller for these transactions. Equity mutual fundsActive stock trading is a skilled full-time job. If you don’t have the time to master it, invest in top equity mutual funds and let the experts do it for you. There are many good fund houses that have plans for every investment objective. They are managed by highly trained investment professionals with years of stock picking experience. Types of equity returnsShares generate returns in two ways – price returns and dividends. Price return is the profit you make when your stock’s price increases. Share prices increase when a company performs well. So, when buying shares, you are essentially betting on the company’s performance.As discussed earlier, shares give you ownership rights in the business and entitle you to a share in its profits. Companies retain most of their profits and spend them on future growth. But they also distribute a part of them to shareholders. This is known as dividend. Dividends are typically announced on a per share bases. So, if you have 100 shares of a company that has announced a dividend of Rs.5 per share, your total dividend will be Rs.500.It is not compulsory for companies to pay a dividend. They can pay a different amount each year or not pay anything at all. Analysing equity returnsPrice appreciation and dividend returns vary from company to company. For a better analysis, you should look at their sum, i.e. total return. Young companies generally don’t pay high dividends because they need to invest in growth. However, they generate great price returns because of their strong growth potential. Mature companies generate moderate price returns because they have limited investment opportunities. However, they can pay higher dividends because they are cash rich. Equity riskEquity investments are highly susceptible to market developments. Also, they don’t guarantee a fixed return like bonds. This makes them high-risk investments.A proportion of this risk is stock-specific or unsystematic. For example, internal labor issues will only affect the shares of the company that is facing them. You can easily mitigate this risk by investing in other companies. Other risks affect most companies and are hard to mitigate. For example, if a country is at war, stocks of most companies in it will be affected. You cannot mitigate this risk by investing in other stocks. Such risks are called systematic or non-diversifiable risks. Don’t let systematic risks bother you because you cannot do much about them. Try to reduce your unsystematic risk as far as possible by building a portfolio that has shares of several companies from different sectors. In ConclusionNow that you have a firm grip on the basics of investment in equities, you are all set to start trading. Remember, stock trading is risky, but risk and return go hand in hand. So, pick your stocks wisely and leverage the expertise of professional investors by including equity mutual funds in your portfolio.Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.
Real Estate Investment in India
What is real estate investment? Real estate is an alternative investment instrument, like the ones we discussed in the previous section. But it merits a separate mention because it is tangible. You can physically own a property and decide to use, rent, sell, or modify it. Other alternative investments are purely financial instruments. They pay returns in a predefined manner during their life and cannot be put to any other use.This piece will tell you all need to know about real estate investing and property investment in India.Types of real estate There are five major types of real estate investing in India:1. Residential – This is the most straightforward real estate investment in India. It includes houses and individual apartments that can be occupied by an individual or a family. It also includes apartment buildings where each unit is occupied by a separate tenant. Tenants pay you a pre-decided rent, usually each month. the duration of their stay depends on the lease agreement. These are generally made for eleven months and renewed on you and your tenant’s mutual consent.2. Commercial – This includes individual office locations, office buildings, and business parks. They usually require a significantly larger investment than residential real estate. But they also attract higher rents. Commercial properties frequently have multi-year leases, which stabilizes your cash flows and increases their predictability. The only challenge is that their rents are highly volatile. They fall more than residential real estate during downturns as businesses downsize or shut down. They increase considerably during upswings as companies hire more people. So, multi-year contracts keep you from taking in new tenants and earning more rent during upswings.3. Industrial – This includes any property that the tenant can use to produce, manufacture, assemble, store, or distribute tangible goods. Common examples are factory locations, industrial warehouses, garages, service stations, and cold storage facilities. Industrial real estate generally generates a large fee and creates opportunities to earn incremental revenue from additional services. For example, if you have rented out a car service station, you may set up a café or a convenience store on it for waiting customers. You may even offer the property on a revenue sharing basis and earn a share of the occupant’s revenues.4. Retail – This includes shopping malls and retail stores. These properties too can be let out on rent basis as wells as revenue sharing basis. In many cases, the landlord asks for a share in the tenant’s revenue, over and above a base rent.5. Mixed-use – This combines many of the above categories on a single piece of land. It is fit for investors who can invest in a large piece of land and develop its separate sections for different uses. it offers built-in diversification because your revenues are not tied to fundamentals that affect one type of real estate. This reduces risk.Income from real estate investments Most real estate investments generate income in two forms:1. Price appreciation: This refers to an increase in a property’s value when it becomes more desirable. This mostly happens because of developments in its surroundings. For example, when a new source of employment comes up in its neighbourhood or when its metro connectivity improves. Its price may also increase because of the upgrades and improvements you make to it. Price appreciation allows you to sell the property for more than you bought it, generating a profit in the process.2. Periodic cash flows: This is the rent you generate when you lease your property. To generate this, you must hold the property for some length of time after buying it.Benefits of investing in real estate 1. Convenience – real estate is not as technical as stocks, bonds, and other financial assets. Many aspects of real estate investing are intuitive.2. Tangibility – Property provides psychological comfort because it stays with you even when its price collapse. You can use it yourself or generate some bare minimum revenue by leasing it.3. Stability – Real estate does not always generate supernormal returns like stocks. But it pays stable rent that can be increased when you renew the lease.4. Insurance – Unlike financial instruments, property can be insured against damage and loss.5. Inflation hedge – Property prices and rents increase with the price level. So, inflation has a limited effect on your financial position when you invest in real estate.In conclusion Real estate is regarded as the simplest investment instrument because investing in a property is less complicated than financial assets. Knowing how to invest in real estate involves a straightforward exchange between the property owner and the tenant. However, properties are of different kinds and each kind has its unique characteristics. This makes real estate investment a skill that needs to be done with expertise in order to get the benefits of investing in real estate. Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.
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