Thanks to the upsurge in investment clubs and institutions offering high monthly returns, Jamaicans have developed a seemingly unquenchable appetite for ‘alternative’ investments. Many investors, no longer satisfied with the regular returns paid by established financial entities, are on a constant search for high-yielding options.

Trading in the foreign exchange market (forex) provided the first opportunity for many ordinary investors to participate in the global investment markets. This investing phenomenon, formally unknown to Jamaicans, was termed an ‘alternative’ investment.

However, with forex being the largest financial market in the world with over US$3 trillion traded 24 hours per day, Sunday to Friday, it hardly seems to deserve to be described as an alternative market.

However, looking at the definition of alternative, it might very well be acceptable to give it this description.  Dictionary.com provides one definition of alternative as “employing or following nontraditional or unconventional ideas and methods existing outside the establishment such as an alternative newspaper or alternative lifestyles.”

Therefore, an alternative investment can let you look ‘outside of the box’ to find opportunities to make money. Let’s look at some other ‘alternative’ investments that exist in the global financial marketplace:

Derivatives

A derivative is a financial product which derives its value from the price of another investment instrument such as a stock, bond, commodity or foreign currency. Derivatives involve the trading of rights and obligations based on the underlying products without directly transferring any of the actual assets.

Investors use derivatives to protect their portfolio assets against negative occurrences, or to speculate to make increased returns. Almost anything can be used as the underlying asset in a derivative contract. Derivatives have been created from abstract things such as hedging against negative effects of the weather.

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However, trading in derivatives can be a very risky investment with the possibility of large losses. One example was the speculative practices of Barings Bank trader Nick Leeson that led to $1.3 billion loss and the collapse of the centuries-old bank in 1995.

Hedge funds

A hedge fund is a private investment fund that pools money from qualified investors and actively seeks to make above average returns on their investment. They are usually only open to a restricted number of wealthy participants. Hedge funds seek aggressive growth by using complex investment strategies such as trading in derivatives and using borrowed money (leverage) to increase the returns.

Unlike regular mutual funds, hedge funds are currently unregulated and this can lead to a lack of transparency about how their returns are made. Hedge funds hold billions of dollars in assets under management, and their activities can have tremendous repercussions on other regulated investment markets.

Structured financial products

Structured financial instruments are specially designed investments that cater to specific needs that are not met from generic financial products. One example of a structured product is a Principal Protected Note (PPN), or Guaranteed Linked Note. A PPN will guarantee the repayment of the original principal amount, but the returns of the investment are linked to the performance of the specified underlying assets.

The PPN is sold as a debt security with a fixed maturity date usually ranging from 5-10 years. However, unlike a regular bond, there are no periodic guaranteed interest payments. Instead, at the maturity of the note the investor receives the original principal and whatever gains are made based on the performance of the basket of securities purchased, less any contracted fees.

Asset-backed Securities

Some assets or receivables that are not easily bought and sold can be pooled into new investment vehicles called asset-backed securities (ABS). The asset pools are made up of income streams such as mortgage loan payments, credit card receivables, car loans and other cash flows. The ABS is basically a bond that uses the pooled investment streams as backing collateral.

Mortgage-backed securities (MBS) are backed by the principal and interest payments of a set of mortgage loans. Investors purchasing MBS are essentially lending their money to home buyers, with the financial institutions acting as middle men. However, as has been demonstrated in the recent mortgage collapse in the United States, if the homeowners cannot meet the monthly mortgage payments, the MBS investors will also suffer.

Real Estate Investment Trust (REIT)

A REIT is a financial instrument that invests in real estate directly through ownership of properties or mortgage loans. Investors can purchase shares in a REIT on a trading exchange, or by participating in a mutual fund that invests in REITs.

Equity REITs invest in real estate by purchasing or building properties, and their revenues are obtained from property rentals. Mortgage REITs lend mortgages to property owners or purchase existing mortgages or mortgage-backed securities. They earn revenue from the mortgage payments. Some benefits of REITs are that they allow investors to participate in real estate without a large investment outlay, and offer liquidity that is not present in the generic real estate market.

The reality is that the global investment market is varied and diverse. While some of these instruments might not be suitable for the average investor, they can provide profitable options if you’re in the market for an alternative.