Accurately valuating investments is essential for making informed decisions when managing a portfolio. At the same time, valuating alternative investments can be challenging in some ways in comparison to valuating traditional investments.
There are a few important factors that are especially important when it comes to evaluating alternative investments. The following are sex key factors to focus on when it comes to alternative investment valuation.
Any applicable target yield that the investment in question involves
If an alternative investment involves a target yield or envisioned interest rate, this will be a key consideration in the valuation of the investment.
Usually, target yield is a more important factor in the valuation alternative investments that are debt investments. However, target yield could also come into play when you are evaluating alternative equity investments as well.
The assets that are present behind the investment
The assets that a company has control of can be a determining factor in evaluating the future value of an alternative investment.
Underlying assets help predict numerous factors, including the returns the investor is likely to receive and the diversification factor the investment offers to the investor's portfolio.
The investment's liquidity
Alternative investments often don't offer the same level of liquidity that traditional investments offer. This makes liquidity an especially important factor when it comes to the valuation of alternative investments.
Certain alternative investments might offer a liquidity that is similar to that of stocks and bonds. For example, currencies and commodities may be considered alternative investments while still offering a good deal of liquidity. However, private debt investments are a type of alternative investment with low liquidity.
Liquidity needs to be considered in a valuation because of the fact that liquidity can vary so much between various alternative investments.
The time frame on the investment
Some alternative investments may come along with a certain time frame that determines when they can be cashed out on. It's important to consider how long an investor will have to wait before realizing the returns on an alternative investment as part of a valuation.
The investment's positioning in the capital structure
The capital structure of a particular investment or loan to an entity refers to the hierarchy of the individual investors/lenders. Those at the top of this hierarchy will receive payment first.
Investors who are lower down in the capital structure are more at risk because they will be the first to realize any losses. To compensate for this, those lower down in the capital structure may also enjoy the potential to receive higher returns if the investment is a success.
An investment's capital structure positioning is therefore an important consideration in evaluating an investment because it provides some indication of how secure the investment is for a particular investor.
The risks that the investment involves
Every type of investment comes along with risks. Both traditional and alternative investments entail risk. However, certain alternative investments might carry a particularly high level of risk, and this is an important factor that comes into play during a valuation.Share