Institutions and endowments have used exotic or alternative investment for decades. During the last boom years, more wealthy individuals and corporations added these instruments to get more diversification and earn hefty returns. The financial crisis of 2008 propelled alternative investments into the limelight.
After the 2008 meltdown
In the aftermaths of the meltdown, many investors grew wary of these complicated investment strategies— collateralized debt obligations, auction-rate preferred securities and other instruments. Consequently, many companies have modified their investment guidelines regarding asset protection and preservation.
Current investment approaches
The new, more conservative investment approach has resulted in enterprises with large cash holdings, which flatten company earnings and corporate treasury portfolio performance. Corporate treasury departments face an array of challenges in their search for yields. These risks include credit, currency liquidity and interest rate. There is also the risks of operational and opportunity cost.
A extended low interest rate environment, market volatility, and out-performance by a particular asset class are all factors that can entice corporation to invest more of their assets into investments.
To balance the asymmetric risk inherent in current fixed income portfolios, many treasurers are under relentless pressure to consider the potential to earn higher returns potential in alternative fixed income or exotic corporate cash investments.
Common types of alternative investments
As treasurers assume more responsibilities beyond managing their company’s working capital, they have become more involve with senior management and directors in managing risk and enhancing profitability with more sophisticated asset allocation strategies, which include the following asset classes
- Private equity – Corporate investors can participate in the growth of private enterprises through long-term investment in private securities for long-term capital appreciation and diversification.
- Managed futures contracts – This strategy uses stock index, interest rate energy, and currency and commodities futures to take advantage of market trends.
- Hedge funds – Fund managers may use advance strategies, such as hedging and levering through derivatives in domestic and global markets, short-selling or other approaches designed to generate strong returns. Hedge funds account for about 40 percent of alternative investment assets.
- Real estate – Real estate makes of a significant percentage of exotic investments. They can the gamut and include vacant land, vacation homes on the lake, beach front condominiums, property in the mountains and foreign real estate investments.
- Rare metals – Besides gold and silver, alternative investments include in rare metals, such as Lithium, Germanium, Platinum, Palladium and Rhodium, used in technology and manufacturing offer attractive investment opportunities.
Pros and cons of exotic investments
These and other alternative investments attract investors for three reasons:
- Low correlation with traditional investments
- Enhance opportunity for portfolio diversification
- Reduce risk.
However, exotic corporate cash investments have different risks and characteristics compared to traditional investment instruments. They are less liquid —and even more so during stressful periods. The complexity and lack of transparency of many exotic investment strategies make them more susceptible to failure.
The appropriate allocation and use of exotic corporate cash investments has the potential to enhance the risk-return profile of the corporate investment portfolio. These investments offer distinctive advantages but also unique risks. It’s critical for corporate treasurers to be comfortable with exotic corporate cash investments when working them into their investment approach.