Alternative Investments at a Glance : Your investment portfolio will typically include conventional investments such as stocks and bonds, both of which are an equally important part of a solid long-term investment strategy.
However, there are many other, less common investments that can complement your portfolio and give you the opportunity to mitigate some of the effects of market fluctuations. Consider alternative investments such as commodities, hedge funds, mutual funds with alternative strategies, and futures to complement your portfolio.
What is alternative investment?
Alternative investments are asset classes that generally do not move in tandem with traditional equity markets and fixed income. They usually follow their own cycle. As a result, the alternative asset class has a low correlation with the standard asset class; therefore they can help diversify your portfolio by reducing overall portfolio volatility when traditional asset classes such as stocks and bonds underperform.
Historically, alternative investments have been restricted to high net worth individuals and institutional investors, but today they are much more available to a wider audience. Alternative investments range from real estate to hedge funds to commodities and can complement a variety of investment strategies. However, they are designed to complement an established portfolio rather than serve as a focal point for the portfolio.
Most people are attracted to alternative investments because they can generate higher returns than traditional investments, but note that higher potential returns can also carry higher risk.
What’s important to note is that alternative investments may be more illiquid than their conventional counterparts – they may not be sold as easily as stocks and bonds – and some may need to be held for longer periods of time. Additionally, there may be unique fees or tax consequences.
Alternative investment options for your portfolio
There are many investment products available today and it is sometimes difficult to clearly identify which investments are conventional or alternative. But below is a list of common alternative investments along with their potential benefits and risks.
Putting a small part of your portfolio into precious metals such as gold or silver can offset the performance of other assets in the portfolio such as stocks and bonds, because precious metals usually don’t move along with conventional investments.
Gold is usually seen as a hedge against inflation and currency fluctuations. So when inflation affects the purchasing power of a currency – let’s say the dollar weakens against the euro – the price of gold tends to rise. As a result, investors put their money in gold during economic and market downturns.
Investing in gold can be done in a number of ways, including futures funds, exchange-traded funds, mutual funds, bullion and coins. However, because precious metals are such a small sector, prices often change dramatically. This type of volatility can create opportunities for investors in the form of high returns but can also result in dramatic losses.
Hedging fund offer
Hedge funds have historically been only available to high net worth individuals and institutions. A hedge fund is a pool of investments that manages money for institutions such as banks, insurance companies, and individuals who meet the federal definition of “qualified buyers” in terms of net worth and income.
Hedge funds are usually set up as limited partnerships where the fund manager is the general partner and the investors are the limited partners. Hedge fund investments tend to have limited liquidity on a scheduled basis as a result these alternative investments are subject to specific regulatory requirements that differ from mutual funds.
Hedge funds invest in a variety of hedge funds with many different strategies and asset classes with the aim of reducing the overall risk of the fund through increased diversification. Hedge fund funds are available to investors who meet accredited net worth standards of at least $1 million. The cost of hedge funds is higher due to the type of portfolio management and increased trading costs.
Hedge fund funds are registered with the SEC under the Investment Companies Act of 1940 and as securities under the Securities Act of 1933. Such funds can also come in the form of private offerings that must comply with more stringent accredited investor standards. Hedge fund funds can be complex investment vehicles that often use leverage, lack transparency, may be subject to restrictions, and may include other speculative practices.
Mutual funds with alternative strategies
Mutual funds are offered in many asset categories, including real estate and commodities. Some mutual funds can mimic the strategy of a hedge fund and may be a good choice if you are interested in alternative investments but do not meet the standards of an accredited investor.
In contrast to hedge funds and hedge funds with higher fees and limited liquidity possibilities, these types of mutual funds are relatively low-cost and highly liquid – they can be easily bought or sold on the general market. As a result they are accessible to a wider range of investors and therefore mutual funds with alternative strategies are prohibited by law from using high leverage to increase yields as is common with many hedge funds.
However, alternative mutual funds do use the investment aspects of hedge funds such as using long and short term investment tactics, trading complex derivatives, and short selling. If you are an investor looking to help keep pace with market changes or changes in a particular sector and you understand the risks that may be involved in investing in alternative investments, alternative mutual funds may be something to consider adding to your portfolio.
Managed term funds
Managed futures funds are formed for the purpose of investing assets in investment vehicles and trading strategies that a commodity trading advisor (CTA) deems appropriate. These specialized money managers use futures contracts, futures contracts, options and other derivative products traded in the US and global markets as their investment vehicle. CTA must be licensed and subject to the regulations of the National Futures Association and the Commodities Trading Futures Commission (CFTC).
Managed futures are speculative, involve high risk, can carry higher costs, and have limited liquidity. However, managed futures investing has become a popular investment for high net worth individuals and institutional investors over the past few decades. Their appeal stems from their ability to provide investors with greater portfolio diversity by increasing exposure to global investment opportunities and other sectors such as commodities.
There are several categories of futures managed in terms of investment structure and objectives. They may be available to investors in the form of private offerings subject to higher accredited investor standards pursuant to the guidelines of Regulation D of the Securities Act of 1933.
Real estate investment trust
A popular alternative type of investment is commercial real estate. Until recently, commercial real estate was largely inaccessible to retail investors and was widely enjoyed by high net worth individuals and institutional investors because of the potential for higher returns and diversification attributes. Since the inception of real estate investment trusts (REITs), investing in commercial real estate has become available to more and more investors.
REITs raise money from investors and invest funds in properties ranging from office buildings to apartment complexes to hospitals and warehouses. REITs are offered to investors in two forms: traded and non-traded. Both offer exposure to commercial real estate assets.
Publicly traded REITs can be easily bought and sold every day on an active secondary market. However, they tend to be more volatile.
Non-traded REITs are illiquid investments suitable for investors with a long term investment period of at least 5 to 10 years. Non-traded REITs are out of sync with stock and bond market movements so they add great diversification to a portfolio.
Alternative investments can also include assets such as art, gems, rare collectibles, and antiques. In addition, venture capital funds are considered an alternative investment. These alternative investments can help provide investors with additional diversification and can help balance performance across changing markets.
Considering alternative investments
Alternative investments have the potential to increase your portfolio returns while helping you reduce market exposure and overall portfolio volatility. However, due to the lack of a secondary market for some alternative investments and limited liquidity for others, as well as the higher risks associated with them, alternative investments should be used to complement traditional portfolios consisting of equities and fixed income instruments.
In addition, because alternative investments often require more professional management than conventional investments, it is important to seek the assistance of an experienced money manager such as your Financial Advisor.
Alternative investments include gold, real estate, hedge funds, hedge fund funds, commodities and others and are generally used to complement the performance of your portfolio as alternative investments are usually not correlated with traditional markets such as equities and fixed income.
Alternative investments are often illiquid, have a longer investment period and carry higher risk, and often require a professional money manager.
Investors must meet the criteria outlined by law, from product to product, to take advantage of alternative investment opportunities.
Alternative investments should generally be used to complement existing portfolios and strategies consisting of stocks and fixed income products.