Alternative investment classes

A balanced investment portfolio is diversified, spreading the risks associated with putting all one’s proverbial eggs in one basket. Therefore, investors must consider various asset classes like equities, bonds/ money market instruments, real estate and the new classes like peer-to-peer funding, cryptocurrencies, crowdfunding and commodities/ derivatives(commodities are not new globally. However, with the commodity exchange in Nigeria just waking up to its potential, they have become an asset class worth considering).

A good investment must not only deliver good returns, but those returns must also cover all costs, including the eroding effects of inflation and currency devaluation. Money market rates are at a record low in many economies. This is particularly true in Nigeria, where inflation is 17.3% and the Naira is at its lowest ever. Investors need to be bullish in finding assets that deliver positive returns whilst being safe and stable.

The artificially low interest rates in Nigeria sent many investors to the stock market in 2020. The Nigerian Stock Exchange (NSE) appreciated by about 50% and emerged one of the best performing stock exchanges globally. Both local and international portfolio managers were rewarded for their faith in the market. 2021 may not bring such rewards as the economic fundamentals are changing. What then are the alternative assets that investors can consider?

Last week, we discussed cryptocurrencies. We pointed out that they are a good store of value which can be held in an investment portfolio like gold is held. Investors need to carefully consider which crypto to buy and then to determine upfront, the price floors/ ceilings at which they would sell the investment and rake in the profits. From what we have seen in recent months, the profit from this asset class is growing geometrically and outstripping inflation but this would not last forever.

Peer to peer funding is like a money market instrument, only the rates are closer to bank lending rates than deposit rates. Borrowers register their financial needs on a platform and investors choose which borrower (peer-to-peer or PAP) to fund after conducting their due diligence. This is the business model of crowdfunding except in this case borrowers (business project owners) need significantly larger amounts of money and require a crowd of investors to provide the funds (hence the term crowdfunding). In the Nigerian market, returns in this asset class range between 25 and 35% per annum. Crowdfunding is considered safer than P2P because the crowdfunding borrower is usually a well established business with proper structures and corporate governance. Crowdfunding platforms conduct due diligence on the borrowers, which reduces the amount of investigation investors need to do. In addition, some crowdfunding platforms are insisting that the business owners get adequate insurance cover, not only to cover normal business perils but also trade credit insurance to ensure that if they are unable to repay the investors, the latter would still get their monies back.

To participate in crowdfunding, an investor registers with a reliable crowdfunding platform. When new investments become available, the platform sends the project details to investors a few days before investment is to commence, to enable them to conduct their own due diligence. All the processes – registration, investment, collection of proceeds are done online.

Commodity derivatives are financial assets that derive their value from the value of the underlying asset e.g. cocoa or cashew. It is a contract that allows investors to benefit from a commodity without actually owning it. Derivative trading is speculative, and investors use algorithms to determine what the price of a commodity would be at a predetermined future date. This price guarantee is beneficial to farmers as it assures them of getting sufficient profit from their commodities. And it would also encourage lending to the agric sector as bankers can be sure that prices would not fluctuate below the benchmark prices for prompt loan repayment. It helps the whole society, as farmers are obliged to produce their commodities at certain standards before they can participate in the exchange.

Other commodities like crude oil, gold and other precious metals are also traded as commodity exchange. To invest in commodities, an investor registers with a mutual fund or exchange traded fund (ETF) that specialises in the commodities the investor is interested in. Investing through an ETF transfers the burden of accurately predicting commodity price trends to the ETF managers, whom the investor chooses only after a comprehensive due diligence exercise. In a good year, the average ETF posts over 20% return on investment.

As you search for alternative, safe, and profitable investments, conduct your due diligence to ensure the assets match your individual risks and returns profile. Happy investing.

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