What are alternative investments?
More investors are shifting to alternative investments, generally referred to as alternatives, yet many still view them as an exclusive, narrowly defined class of investments. This is far from the truth. Alternatives come in a variety of packages and encompass a wide range of assets and strategies.
What defines alternative investments?
In general, there are two main types of alternatives. The first type are investments in assets other than stocks, bonds and cash, such as infrastructure, real estate and private equity. The second type involve investment strategies that go beyond traditional methods, such as short-selling and leverage.
Traditional vs. alternative investments
What differentiates alternative investments from traditional investments?
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| Traditional investments | Alternative investments |
| Strategies constructed primarily using public equities and bonds. They are characterized by: |
Investments that look to exploit market inefficiencies by focusing on non-traditional assets and investment strategies. They are characterized by: |
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Myth-busting Alternatives
A lot of misunderstanding surrounds alternative. Some investors still think of them as high-risk, exotic funds reserved for ultra-high-net-worth individuals and institutions. However the reality is that alternatives can be an integral part of nearly every investor’s portfolio.
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Reality: While some alternatives can experience higher levels of volatility than traditional equities and bonds, as a group they may not necessarily be more volatile than any other investment. In fact, many alternatives experience far less volatility than the stock market.
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Reality: Alternatives represent different approaches to investing across a variety of markets and vehicles. A useful way to think about alternatives is to differentiate between their “contents” – the assets or strategies that determine how individual investments might be expected to perform – and their “containers,” the fund structure that will determine transparency and access to capital.
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Reality: Just as adding one stock or mutual fund does not lead to significant diversification, a single alternative investment may have limited impact. Investing in only one alternative strategy may provide some diversification benefits, but can also concentrate risks.
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Reality: The liquidity of alternatives depends on the individual investment. Some alternative mutual funds provide daily access to cash. Limited partnerships, on the other hand, can have restrictions from 30 days to longer than 10 years.
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Reality: Individual investors have greater access to alternatives than ever before due to innovations in product structures. Open-end mutual funds, for example, have no-or-low barriers to investing. Other structures, such as registered closed-end funds and unregistered funds, have some limits on who can access them.
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Reality: It's true that correlations across nearly all investments tend to converge under periods of extreme market stress. Even during crises, however, history shows that alternatives typically have not fallen as far as stocks, providing a cushion for investors.
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Reality: The fees for alternatives vary and depend on the fund’s structure. An alternative’s “container” usually indicates the fees an investor can expect to pay. Partnerships typically entail management and performance fees. Mutual funds charge a management fee but no performance fee.
