When it comes to investment options, investment choice is not a matter of either-or regarding individual security, vehicle, or product. It is usually a blend of what will match your reasonable return requirements at the lowest level of risk.
To generate a supplementary income for your retirement the main investment options to consider are cash investments, retail bonds, voluntary purchase annuities, income plans, a share portfolio (equities), collective investments (unit trusts), property, reverse mortgages etc.
These products are common in most portfolios, but alternative investment options like derivatives, hedge funds, private equity funds and structured products are also available and could enhance investment returns. However, tread with caution and always make sure you get the input and advice from your registered financial planner.
What is an alternative investment?
If you are interested in a derivative, consider that it is a contract between two parties based on the sale and purchase of an underlying security like shares or bonds, a currency or commodity and even an exchange-traded fund (ETF) and interest rates. They derive their value from that of the underlying instrument or product – hence the name.
Although derivatives are used extensively by professional investment managers, individuals should administer caution, since you need expert knowledge to use derivatives effectively. Most derivatives are traded on the expectation of the price of the security or item at a future agreed date and can be higher or lower than the current price. It can be traded on or off a stock exchange and can be used to protect against risk by diversifying a portfolio, speculating (with various levels of risk) or hedging by buying insurance to protect you against losses.
Hedge funds can be complex and costly, and you’ll need some expertise to understand them. Since they are regulated in South Africa in terms of the Collective Investment Schemes Control Act by the Financial Sector Conduct Authority (FSCA), funds sold to individuals must be registered as retail registered hedge funds. This regulation places limits on the funds to limit risks.
Hedge funds do come with many levels of risk, which tend to be extensive. These include the use of leverage/gearing where money is borrowed to hopefully make more money, but with the potential to lose more money. Other risks involve high-risk investment strategies like buying what is called stressed or junk debt, offering high returns but a bigger chance of the money not being repaid, and liquidity where you may only be able to access your investment in an emergency by paying a penalty.
With most hedge funds being global funds, hedge fund managers make extensive use of derivatives, which allows them to make money on moving markets by speculating on where they believe the price of a security or commodity may be at some time in the future. Although hedge funds can be accessed individually, the amounts required are often very large and picking the right fund is very difficult. For South African investors, hedge funds are available through multi-manager options, which reduces risk, makes use of expert multi-managers and look at hedge funds with at least 15 underlying funds to further decrease your risk.
Another alternative investment option is private equity funds that provide capital to enterprises that are not listed on the stock exchange like venture capital, development capital and buyouts. To invest in private equity takes expertise and a lot of investigation to ensure that your money does not disappear into a no-hope business or crooked venture.
The safest way for individuals to approach private equity investing is through a multi-manager portfolio. A benefit of this is where the fund-of-funds manager conducts extensive due diligence on prospective fund managers and seeks to select the best funds and fund managers. Diversification of manager, investment and, in some cases, geographic risk is also achieved, while extensive corporate-governance oversight of the fund managers is conducted.
To access private equity investments, one can do it by directly investing in private-owned companies not listed on a stock exchange or through companies listed on the JSE Securities Exchange that specialise in listed venture-capital companies, and indirectly through life assurance endowment policies with underlying investments in private equities.
These investment options can be very rewarding but need extra care to decrease your risk and prevent the wipe-out of your hard-earned money. It is therefore imperative to seek out the counsel and advice of a registered financial advisor to assist in making the investment(s) most applicable to your requirements and appetite for risk.