What are alternative investments?
Broadly speaking, alternatives are investments in assets other than stocks, bonds and cash, or investments using strategies that go beyond traditional methods, such as long/short or arbitrage strategies. Since alternatives tend to behave differently than typical stock and bond investments, adding them to a portfolio may provide broader diversification, reduce risk and enhance returns.
Are alternative investments good?
Alternative investments are useful investment strategies for investors looking to diversify their portfolios from traditional funds. If that sounds like you, consider including some of these popular alternative investments in your portfolio:
With their range of trading strategies and participation in non-traditional markets, hedge funds can provide a level of diversification to a portfolio that can be hard to find elsewhere. Some distinguishing features of hedge funds are:
They offer a broad opportunity set and fewer restrictions on investments, and can include investments that are less correlated. This means an investor may be less impacted by market extremes or volatility.
They employ trading strategies that seek out market inefficiencies, allowing highly skilled managers to add significant value over time.
They are grouped in five categories: Long/Short Positions, Managed Futures, Global Macro, Distressed and Multi-Strategy.
Investing in private companies offers the potential for enhanced diversification and returns, since the factors driving these markets differ from those that drive public equity markets. Benefits of private equity investing can include:
Private ownership enables long-term strategic focus, versus the public market focus on quarterly earnings.
Overall, returns on private equity investments have exhibited attractive performance on both a risk-adjusted and an absolute basis.
Private equity investments provide a spectrum of opportunity by spanning all stages of a company’s life cycle, including during venture capital, growth periods, buyout and restructuring.
Historically, investment in commodities such as natural resources — including agricultural products, energy, precious metals and industrial metals — comes with several benefits. Benefits of commodity investing can include:
Commodities rise and fall with supply and demand. The more a commodity is in demand like oil or natural gas, the higher price, and profit for the investor, will be.
Commodities protect against inflation. They are not sensitive to public equity market movements, so they are a natural protection from risk in that arena.
The most popular types of commodity investments include:
Index funds: These funds track an index that includes various commodity assets.
Commodity funds: Known as "true" commodity funds, these funds invest directly in the underlying commodity asset. An example would be a commodity fund that holds a direct position in gold and oil.
Futures-based commodity funds: These funds offer exposure to commodities by investing in futures contracts without ever buying the actual underlying commodity assets. This type of investment may carry higher risk due to the volatile nature of the futures contracts market.
Real estate is another popular and flexible investment strategy for portfolio diversification. Contrary to popular belief, real estate investing is not just for wealthy investors. Publicly traded exchange traded funds (ETFs) and trusts allow investors low barriers for real estate investing strategies. Benefits of real estate investing can include:
Real estate can be a good source of diversification, because it is less correlated to stock, bond and cash returns over the long term.
Real estate is a strong generator of immediate cash flow and offers the potential for capital gains.
Real estate investment trusts (REITs) combine the potential of real estate's increasing value over time with the transparency and liquidity associated with publicly traded stocks. This type of investment may carry higher risk.
How do alternative investments work?
Alternative investments are often met with misunderstanding. Some investors still think of alternatives as high-risk, exotic funds reserved for ultra-high-net-worth individuals and institutions. The reality is that alternative investments can be an integral part of nearly every investor’s portfolio.