When good quality bonds offer so little income and shares have gone up so much, people naturally ask if there are other ways of investing money that would provide a good return. There is a constant search for different ways of putting savings to work, and a great deal of ingenuity in the financial markets of how you might be able to find an asset that is different from equities or bonds.
A good-quality bond is a loan from savers to a government or large company. The bond allows you to stop lending to the government by selling your portion of the loan onto someone else in the market without making the borrower pay the money back. If interest rates fall while you own a bond its value usually goes up, or falls when interest rates rise, as potential buyers want to get a market return on their bond investment.
When a central bank puts up rates, savers want a higher return on money they lend. A conventional bond pays a fixed amount of interest regularly, so if rates rise you need to pay less for the bond to get the return.
An equity is a long-term investment into a company that invests your cash in its business. It usually buys you a share of all the profits and assets the company generates and gives you a vote in choosing the management. The share is not usually paid back but can be sold on to a new owner. When economies fall into recession – or when some bad news hits the company or its area of working – the share price will usually go down. Investors usually buy into limited liability companies which means they cannot lose more than the amount they paid for the shares, however much the company may lose.
Property is one of the most important alternative assets. It has some of the characteristics of a share and some of a bond. Like a share, you participate as an owner in the capital value changes and enjoy the rental income paid on the property. More like a bond, rental payments take priority with interest charges over the payment of dividends by a company.
Unlike both a bond and share, property investment can take a long time to buy and sell and brings with it a wider range of responsibilities. It can involve you in repair costs, tenant disputes and other management issues. To reflect this the rental income return on many commercial properties in advanced countries has in recent years been higher than the interest on a government bond or the dividend on the average share.
Investment in direct property is difficult and expensive for investors other than very large funds. Commercial property lots are multiple millions in value, and you need several investments to provide a spread. You need to be able to tie the capital up for several years, and to accept that you might not be able to sell at a sensible price when you wish if the market is then in a down phase.
For the larger fund, with more than, say, £100m to spend on property, the rewards can be good, especially with active management looking for ways to enhance value, change use or develop further. Smaller investors can seek to get some of the characteristics of property by investing in property funds where a professional manager accumulates sufficient capital to build a good diversified portfolio and has the money to pay the professional fees to manage it well. These funds themselves though are illiquid, so do not rely on getting out of them in a hurry if the market is weak.
Hard assets and basic materials
Commodities are another asset class that is different to equities and bonds. You can buy and hold the physical commodities themselves to seek a return from rising prices, though this entails management costs to acquire suitable warehousing and to ship and store the product. Alternatively, you can buy an index or a fund which holds future entitlements to acquire the preferred commodities.
The manager will roll over the futures contracts to avoid having to take delivery. These funds are seen as more speculative or risky than many share and bond funds. The commodities do not yield any income, so the whole investment is based on expecting the price to rise for whatever reason. Some people like to have a holding in gold, whether the metal itself or gold coins or a future or fund. They see it as a way of avoiding the inflation inherent in paper currencies, though of course the gold price itself can be very volatile as measured in dollars or pounds.
Some argue that hedge funds or absolute return funds are an alternative asset class. They are rather different ways of managing the share, bond and future classes of asset already out there. There are many clever ideas to try to create a more stable positive return than shares or bonds allow. Most of them entail higher fees for the manager, and usually entail lower returns when shares and bonds are doing well. The successful ones find a good way of avoiding losses when share and bond markets fall, to offset or improve on the returns on traditional share and bond funds that rise and fall more with their markets.
There is no best alternative or right answer. Each one of these assets or styles of fund need assessing for the amount of risk and the likely return. The more complex the fund, the more analysis and advice is needed to make sure it is worth buying. A professional portfolio manager may use some of these asset classes from time to time to provide a different mixture of returns and risks within the portfolio.
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