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Top 5 Alternative Investments for Portfolio Diversification

  • Writer: Steadfast Equity
    Steadfast Equity
  • May 12
  • 11 min read

Updated: May 18

If you're looking to diversify your portfolio beyond stocks and bonds, alternative investments might be the answer. These options not only reduce risk through low market correlation but can also align with ethical goals. Here are five key alternatives to consider:

  1. Green Bonds: Finance environmental projects while earning fixed income. Offers transparency and impact reporting.
  2. Tech Startup Private Equity: High-risk, high-reward investments in innovative companies. Requires due diligence and long-term commitment.
  3. Social Impact REITs: Combine real estate returns with societal benefits like affordable housing.
  4. Responsible Commodity Futures: Trade commodities with ESG (Environmental, Social, Governance) factors in mind.
  5. Community Development P2P Lending: Support underserved local projects while earning potential returns.

Quick Comparison

Investment Type

Risk Level

Liquidity

Key Benefit

Example Use Case

Green Bonds

Low to Moderate

Moderate

Funds environmental projects

Renewable energy financing

Tech Startup Private Equity

High

Low

High growth potential

Early-stage AI company investment

Social Impact REITs

Moderate

Moderate

Real estate + social impact

Affordable housing developments

Responsible Commodity Futures

Moderate to High

High

Diversification + inflation hedge

Sustainable agriculture contracts

Community Development P2P Lending

Moderate to High

Low

Direct support for local communities

Small business loans

These options suit different goals, risk tolerances, and timelines. Always assess your financial needs and consult a professional before investing.


The Importance of Alternative Investments in 2024 & Beyond


1. Green Bonds: Fixed Income for Environmental Projects

Green bonds are a financial tool designed to support climate and environmental initiatives. Since their inception in 2007, the market has grown significantly, surpassing USD 1 trillion in cumulative issuance. Backed by strong credit ratings and mandatory impact reporting, they’ve become increasingly attractive to investors.

Here’s a breakdown of the main types of green bonds:

Type

Description

Recourse

"Use of Proceeds" Bond

Funds allocated specifically for green projects

Full recourse to the issuer

Project Bond

Finances individual green projects

Limited to the project’s assets

Covered Bond

Supports qualified green projects

Dual recourse to the issuer and a covered pool

Green ABS

Refinances portfolios of green projects

Backed by grouped project assets

This variety highlights the flexibility of green bonds in addressing different environmental funding needs. For instance, in March 2024, Alliant Energy’s Wisconsin energy company, WPL, issued USD 300 million in green bonds with a 5.375% yield. This example shows how green bonds can offer competitive returns while funding sustainability efforts.

"Green bonds were created to fund projects that have positive environmental and/or climate benefits." – Climate Bonds Initiative

Green bonds come with several defining features:

  • Credit Quality: Interest rates are tied to the issuer’s credit rating.
  • Impact Reporting: Investors receive detailed reports on the environmental benefits achieved.
  • Investor Base: These bonds appeal to ESG-focused investors, enhancing market liquidity.
  • Transparency: Comprehensive reporting ensures clarity on how funds are used.

This focus on transparency builds confidence among investors. As Marcelo Giugale, Director of Financial Advisory and Banking at The World Bank, explains:

"When a public official or a private CEO goes through the trouble of committing to a certain additional expenditure, they are telling the world how much they care about it, and how ready they are to make it a priority."

Green bonds not only provide financial returns but also contribute to addressing global environmental challenges.


2. Tech Startup Private Equity

Investing in tech startups through private equity offers a way to diversify portfolios while balancing financial goals with ethical practices. Similar to green bonds funding environmentally friendly initiatives, tech startup investments can align ethical considerations with the potential for high returns. This approach combines responsible decision-making with a focus on financial growth.

Private equity firms currently hold $1.14 trillion in liquid assets ready for investment. With the help of AI-powered tools, investors can streamline due diligence processes and evaluate environmental, social, and governance (ESG) factors. These tools provide valuable insights while helping manage risks effectively.

When assessing tech startup investments, consider the following framework:

Assessment Area

Key Considerations

Risk Mitigation Strategies

Technology Infrastructure

Cybersecurity measures, data protection

Regular security assessments, ongoing monitoring

Revenue Structure

Recurring vs. one-time revenue, sales pipeline

Probability-weighted revenue forecasting

Customer Base

Concentration risk, relationship strength

In-depth customer analysis

Market Position

Competitive advantage, growth potential

Industry-specific due diligence

Interestingly, around 55% of investors now require their general partners to undergo cybersecurity risk assessments, reflecting growing awareness of digital vulnerabilities.


Key Risk Management Strategies

  1. Comprehensive Due Diligence Leverage AI-driven platforms to automate due diligence questionnaires (DDQs) and ESG surveys. These tools enhance efficiency and ensure thorough evaluations.
  2. Value Protection Measures Safeguard investments by implementing strategies such as:
    • Earn-out mechanisms linked to performance outcomes
    • Seller equity retention clauses
    • Strategic holdback periods to ensure accountability
  3. ESG Integration Evaluate startups using established ESG frameworks like CDP, CSRD, SASB, and SFDR. These standards provide a structured way to assess ethical and sustainability practices.

3. Social Impact REITs

Social Impact REITs combine real estate investments with a focus on creating positive societal change. These investments address pressing issues like affordable housing while aiming for competitive financial returns. Real-world examples highlight the benefits of this approach.

Take SoLa Impact, for example. Operating in South Los Angeles, they manage over 1,500 apartments and have plans to add another 1,500 affordable housing units. Their tenant base includes:

Tenant Demographics

Percentage

Housing Subsidy Recipients

70%

Below Poverty Line

60%

Formerly Homeless

53%

Domestic Violence Survivors

33%

Another standout is Turner Impact Capital, which has significantly scaled social impact investing. With over $6 billion deployed, they’ve created 59,000 school seats and provided housing for 61,700 residents. CEO Bobby Turner challenges the notion that social objectives hurt financial returns:

"Most investors believe if you are going to impose a societal objective on a financial return you're going to sacrifice yield. I just refute that. Our results do, too."

Performance Metrics and Risk Management

Social Impact REITs have shown they can deliver both financial and societal benefits. For instance, Social Housing REIT generates $2.19 in social value for every $1 invested. Their portfolio includes 3,424 homes across 494 properties, with more than 60% being either newly built or recently renovated.

However, there are risks to consider:

  • Market Dynamics: These investments are influenced by factors like interest rates, inflation, and employment trends. Interestingly, they show low correlations with traditional assets, such as a 0.12 correlation with stocks and -0.14 with bonds between 2000 and 2020.
  • Impact Measurement: Investors should prioritize funds that define clear performance indicators and provide regular updates on both financial and social outcomes.
  • Regulatory Compliance: Navigating complex reporting requirements demands thorough due diligence to ensure transparency and compliance.

Social Impact REITs not only align with diversification goals but also address critical challenges. For instance, the real estate sector contributes over 40% of global carbon emissions, and with one in five Americans expected to be 65 or older by 2030, the demand for socially conscious investments is only growing. These REITs are uniquely positioned to meet these needs while delivering meaningful returns.


4. Responsible Commodity Futures

Responsible commodity futures bring ESG (Environmental, Social, and Governance) factors into the commodities trading world. They not only help diversify investment portfolios but also encourage more sustainable practices in production and trading.

The commodities market is massive, with an annual trading volume of about $20 trillion. Beyond financial gains, these futures serve as a hedge against inflation while supporting environmentally and socially conscious production methods.


ESG Integration and Value Creation

Not all commodities are created equal when it comes to their environmental impact. For example, the greenhouse gas emissions from crude oil can vary significantly - up to 12 times higher depending on its source. This variability allows investors to choose futures contracts that prioritize sustainability, much like other ethical investment options.

ESG Aspect

Traditional Futures

Responsible Futures

Environmental Impact

Not considered

Tracks emissions, water usage, deforestation

Social Responsibility

No requirements

Monitors labor practices and community impact

Price Premium

Standard pricing

May include a premium for sustainability

Risk Management

Focus on market risk only

Includes ESG risk assessment

By factoring in ESG criteria, responsible commodity futures not only enhance ethical investing but also align with new market standards that aim to make trading more sustainable.


Market Innovation and Standards

One key development in this space is the Commodity Genome Project (CGP), which aims to standardize ESG evaluations in commodity markets. Curtis Ravenel, Senior Advisor to Mark Carney and COP26 Finance Advisor, highlights its importance:

"The CGP is a lingua franca for anyone working to create digitized, regenerative commodity markets, unlocking the enormous potential to make measurable progress toward increasingly ambitious climate goals."

Karl Burkart, Deputy Director of One Earth, underscores the shift happening in private markets:

"The 2020s will be a decade when, for the first time, private markets will be able to differentiate between commodities based on their environmental attributes. This is a game-changer."

These innovations are helping reshape the commodities market, making room for more ethical and sustainable practices.


Performance and Portfolio Benefits

Between January 2011 and July 2020, commodity futures markets saw significant volatility, ranging from 21% to 132%, and returns fluctuating between -52% and 9% annually. Despite this, they offer several advantages:

  • Diversification: Low correlation with traditional assets enhances portfolio balance.
  • Inflation Protection: Acts as a natural hedge against rising prices.
  • Lower Costs: Avoids the high expenses of storing and insuring physical commodities.
  • Market Liquidity: Easier entry and exit compared to direct commodity investments.

For better diversification, focusing on individual futures contracts instead of indices may be more effective. But investors should be prepared for some obstacles.


Implementation Challenges

Navigating responsible commodity futures isn't without its difficulties. Investors face hurdles like complex certifications, verifying ESG data, and liquidity constraints. Partnering with platforms that provide detailed ESG profiles and clear impact metrics can help mitigate these issues.

Technological advancements, especially in blockchain and remote sensing, are also improving transparency and making it easier to verify sustainability claims. These innovations are paving the way for a more ethical and efficient approach to commodities trading.


5. Community Development P2P Lending

Community development P2P lending directs funds toward underserved local projects, combining the potential for attractive returns with a measurable impact on local communities.


Understanding the Mechanics

P2P lending platforms connect investors directly with borrowers, focusing on initiatives that stimulate local economic growth and empowerment. Here's a quick comparison of how these platforms stack up against traditional bank lending:

Aspect

Bank Lending

Community Lending

Interest Rates

Standard bank rates

Can be lower for good credit or higher for riskier borrowers

Approval Process

Strict institutional criteria

Flexible, emphasizing community-focused considerations

Investment Returns

Limited to savings rates

Potentially higher returns (with greater risk)

Social Impact

Minimal

Direct support for community development

This approach places a strong emphasis on channeling resources to areas that need them most, but it's crucial to understand the associated risks and rewards.


Risk-Return Profile

Community P2P lending offers a unique risk-return dynamic. While traditional commercial bank loans had a delinquency rate of 1.44% in Q2 2024, P2P platforms often face default rates exceeding 10%. This highlights the importance of balancing the potential for higher returns against the elevated risks.


Investment Strategy Considerations

"P2P lending promotes financial inclusion by offering loans to individuals and businesses that may be overlooked by traditional financial institutions. This inclusion helps bridge the gap between the unbanked and the formal financial system, providing opportunities for all to participate in the economy."

Ways to Maximize Impact

  • Target Specific Needs: Focus on industries or communities with the greatest demand for capital.
  • Collaborate Locally: Partner with non-profits or community organizations to enhance outreach.
  • Support Education: Engage in platforms that promote financial literacy for borrowers.
  • Track Impact: Monitor both financial performance and the social benefits achieved.

Managing Risks

Investing in community P2P loans requires careful consideration of liquidity needs and risk tolerance. These loans are not backed by government guarantees and carry a higher risk of default. Despite this, they offer a compelling opportunity to achieve financial returns while contributing to local economic growth.


Investment Options at a Glance

Here’s a quick overview of alternative investments to help you diversify wisely:

  • Green Bonds: These are used to finance environmental projects and typically carry a lower to moderate risk. Research indicates their yields can vary compared to traditional bonds.
  • Tech Startup Private Equity: A high-risk, high-reward option. It requires long holding periods and offers limited liquidity but can yield substantial returns.
  • Social Impact REITs: These combine real estate investments with a focus on social impact. Historically, they’ve shown strong performance over decades when compared to market indices.
  • Responsible Commodity Futures: Ethical investments in commodities come with diverse risk levels, returns, and holding periods.
  • Community Development P2P Lending: This option funds local community projects. It carries moderate-to-high risk and is less liquid.

Risk-Return Profile Analysis

The demand for alternative investments is growing. By 2028, these assets are expected to climb to a value of $24.5 trillion. This reflects a shift among investors seeking options beyond the typical 5% returns offered by traditional investments.


Liquidity Considerations

PIMCO highlights the importance of liquidity when it comes to alternative investments:

"Alternatives involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment."

This underscores the need to evaluate liquidity constraints before diving into these investments.


Market Correlation

One key advantage of alternative investments is their lower correlation with traditional markets, which can help reduce overall portfolio volatility. However, each option carries its own unique risks. Make sure to align your choices with your financial goals, risk tolerance, and time horizon.


Next Steps

Thinking about adding alternative investments to your portfolio? Here's a straightforward plan to get started. Follow these steps to build a portfolio that can weather market changes.

Evaluate Your Risk Tolerance

Start by understanding how much risk you're comfortable taking and how long you plan to invest. If you're new to alternative assets, consider beginning with a smaller, more cautious allocation and expanding as you gain experience.

Research Investment Details

Each type of alternative investment has its own requirements. Be sure to look into factors like liquidity, holding periods, and the amount of capital needed. This will help you choose options that fit your financial goals and timeline.

Do Your Homework

For socially responsible investments, dig into ESG ratings from sources like Morningstar. Check the performance history to ensure the investment balances social impact with potential returns. Also, verify that it meets standards such as GRI or UN PRI.

Seek Expert Advice

Work with financial professionals who specialize in alternative investments. They can help you find opportunities that align with your goals and guide you through market challenges.


FAQs


What are the key risks of investing in tech startup private equity, and how can investors manage them?

Investing in tech startup private equity comes with its fair share of challenges. Among the most pressing are cybersecurity threats, technology failures, third-party vulnerabilities, and compliance issues. A cyberattack or data breach can tarnish a company's reputation and diminish its value. Similarly, if a startup relies on unproven or faulty technology, it risks operational breakdowns. Dependence on third-party vendors introduces another layer of uncertainty, while internal fraud or misconduct can create significant setbacks.

To navigate these risks, investors need to dive deep into due diligence. This means examining the startup's regulatory track record, assessing its cybersecurity measures, and understanding its internal governance structure. It’s equally important to keep an eye on their technology risk management strategies and ensure they have a solid crisis management plan ready to go. Staying updated on changing regulations and encouraging strong compliance practices can add an extra layer of protection, helping to safeguard investments and promote steady growth.


What sets responsible commodity futures apart from traditional ones, and how can incorporating ESG factors benefit these investments?

Responsible commodity futures set themselves apart from traditional ones by weaving Environmental, Social, and Governance (ESG) principles into the investment process. Instead of solely focusing on profit, these futures emphasize ethical and sustainable practices - like backing renewable energy initiatives or ensuring fair labor conditions within supply chains.

By factoring in ESG considerations, these investments can offer several advantages. They help reduce exposure to risks related to environmental or social challenges, align with personal values, and tap into long-term growth potential as the demand for sustainable solutions continues to rise globally. For those seeking to combine financial returns with meaningful impact, responsible commodity futures present a thoughtful way to diversify portfolios while contributing to positive progress.


What factors should investors evaluate when selecting green bonds, and how do these bonds support environmental projects?

When considering green bonds, there are a few essential factors to keep in mind: the environmental benefits of the project, the trustworthiness of the bond issuer, and the bond’s financial viability. Additionally, it’s crucial to verify that the funds are being directed toward legitimate and transparent green initiatives.

Green bonds are designed to support projects that promote environmental well-being, such as renewable energy ventures, sustainable infrastructure development, or conservation programs. Investing in these bonds not only adds diversity to your portfolio but also aligns your investments with efforts to protect the planet - making them a compelling choice for those who prioritize socially responsible investing.


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