The Principles of Alternative Investments Management

Investing constitutes an essential factor in economic growth and development. Investments also function as the main manner of expanding capital. There are many definitions of the term ‘investment’. One of most well-known definitions, considered as a classic one, is the concept proposed by Hirshleifer (1958). He claimed, that investing involves sacrificing the current goods in exchange for uncertain benefits in the future. In an economic sense, an investment is a purchase of goods that are not consumed today, but are used in the future to create wealth. This definition indicates few important characteristics of investments. Firstly, an investment denotes an investor’s abandonment of current consumption, for which he/she expects a certain reward (a benefit). Secondly, an investment is realized during a certain period of time, which means that the investor can receive the reward in the future. Thirdly, future benefits constituting the reward are uncertain.

Currently, hedge funds are the most well-known alternative investment institutions. They emerged on the capital markets in the 70s and 80s. They evolved as a consequence of development of new financial instruments, such as e.g. derivatives. Also, limitations in functioning and in investing methods of traditional investment funds and pension funds have contributed to development of hedge funds.

Investment strategies, narrowly speaking, encompass and describe the behaviors and decisional assumptions of the entities investing on the market. An investment strategy is a set of rules and patterns of behavior, through which an investor intends to pursue his/her orders of buying and selling on a given market. Alternative investments are characterized by a very broad range of investment opportunities, while offering multiple risk and the return rate combinations, which generally are unavailable through application of traditional investment methods. Understanding the possibilities of shaping the risk profile and the return rate by the managers working under alternative strategies is one of key aspects of alternative investments.

Over the past few year, interest in investing through funds of funds has been increasing. Funds of funds are entities investing financial assets in the shares, units or in certificates of other investment funds. Funds of funds play a significant role on the market of alternative investments. According to the statistical data published, the value of the assets in funds of funds currently constitutes about 30 % of the assets of all hedge funds (http://​www.​ifsl.​org.​uk). This means that, from the hedge funds’ perspective, those entities constitute a very important aspect of the demand.

Analysis of a type of investments called managed futures should begin with introduction of the derivatives to the subject of the matter, particularly of the futures contracts, which constitute a direct object of this type of investments. Derivatives are the futures market’s tools, the value of which depends on the value of the so-called primary instrument constituting the base of a futures transaction. These innovative instruments of the financial market can be used both for hedging, arbitrage as well as for speculation that allows profiting on the changes in the basic instrument’s price.

Structured products are a combination of traditional investments into stocks and bonds with investments in derivatives. A combination of traditional instruments with more innovative ones allows the investors to generate higher return rates. A traditional instrument is meant to protect the capital invested in an investment. A derivative is meant to multiply an income. Creation of asymmetrical payout profiles is possible by using e.g. options. Such financial vehicles are designed to better fit the changing conditions on the financial market. Development of the market of structured instruments is an answer to the changing investor demand. The current low interest rates environment and a simultaneous decrease in attractiveness of bank deposits has motivated individual investors to become interested in structured products, which offer potentially higher return rates. The demand for structured products is also linked to the exposure to risk of those assets, which are not necessarily available to the investors on the base market. Structured products, similarly to other alternative investments, also allow the possibility of diversifying the investment portfolio, thus allow reduction of the investment risk and provide access to various investment structures. Some of these structures also enable tax savings (unit-linked products).