What Are Alternative Investments?

Because they’re unconventional (and often high-risk), alternative investments are typically held by institutional investors and high-net-worth individuals. However, that doesn’t mean they’re out of reach for regular individual investors. For certain investors, alternative investments provide the potential opportunity to further diversify their portfolios, boost returns, and look beyond the stock markets to build wealth. 

How alternative investments work

You may see alternative investments referred to simply as “alternatives” or “alt investments.” While the list of alternatives is long and varied (and we can’t cover them all in one article), here are five types that you’ll commonly come across in the market. 

• Private equity (PE) is a capital investment in private companies (read: nonpublicly traded) to help them grow their business. Because the minimum investment requirements can be quite high (we’re talking about millions of dollars), PE investments are generally only available to high-net-worth or accredited investors. 
• Hedge funds are investment funds that use complex investment strategies to generate high returns. Like PE, hedge funds are typically limited to high-net-worth investors as well as institutional investors. 
• Real estate includes properties like residential apartments, office buildings, and even timberland and farmland. Real estate investment trusts or REITs are also part of this category.
• Commodities include assets like precious metals, oil, natural gas, and agricultural products. Investing in commodities is often considered as a way to hedge against inflation.
• Collectibles are any rare, specialty items whose value might grow over time. This category includes things like artwork, vintage wines, classic cars, custom watches, baseball cards, toys, and comic books. 

You can see just how broad the alternative investments category can be. One important thing to keep in mind is that each type of alternative comes with its own level of risk and complexity – as well as investment considerations (how they’re traded and valued, their accessibility, liquidity, fees, costs, etc.).

So for example, the approach you might take to investing in fine art will likely be different from how you invest in, say, a hedge fund. Whatever asset you may be considering, know that investing in alternatives generally requires a great deal of research and due diligence.

Alternative investments do share a few general characteristics.

• They’re typically considered illiquid assets.
• They’re often unregulated (or face fewer regulations) by the Securities and Exchange Commission (SEC).
• They typically have a low correlation to standard asset classes. In other words, they don’t usually move in the same direction as traditional assets in the stock or bond markets.
• They can be difficult to value. Depending on the asset, information about its pricing and performance might be hard to come by.

Let’s use a piece of artwork as an example. It’s relatively illiquid, compared to a traditional asset like stocks, because it may take some time for you to find a buyer. It can also be difficult to judge an artwork’s value. To find out, you usually have to take the piece to appraisers. And you’ll probably run into some disagreements there. After all, what is art? Compare this to a stock, whose price you can look up online almost anytime.

Why people invest in alternative investments

At this point, you may be wondering why people bother with alternative investments. After all, they’re relatively illiquid, largely unregulated, and complex – or in fewer words, high-risk.

Some people see alternative investments as a way to hedge against inflation and build wealth outside of the traditional financial markets. 

The opportunity for diversification and higher returns is also appealing to some investors. 

• Diversification. Alternatives give investors an opportunity to diversify their holdings – outside of the stock and bond markets. Remember when we mentioned that alternatives typically have a low correlation to standard asset classes? This is why some investors see alternatives as a potential diversification tool that can help reduce their exposure to the stock market. 
• Potential high returns. Because alternatives can give investors access to a broader set of investments and strategies, there is a potential to earn higher returns (compared to investing in traditional assets). Yes, alternatives tend to be high-risk, but there’s also the possible opportunity for high rewards.

But in recent years, growing interest in alternative investments has made it possible for regular individual investors to invest in certain alternatives.

For example, there are alternative mutual funds (aka “alt funds” or “liquid alts”) that invest in non-traditional assets like real estate and commodities. While many types of alternative assets aren’t regulated, alt funds are publicly traded and registered with the SEC. 

If you’re exploring alternative mutual funds as a potential investment option, it’s a good idea to talk to your financial or investment advisor first to see whether they’re a good fit for you and your goals as well as understand their potential risks. 

The bottom line

The world of alternative investment is large. It comes with a long and varied list of non-traditional assets and investment strategies to consider. Despite their level of risk and complexity, alternative investments can be appealing, as they offer the opportunity for some investors to further diversify their portfolios, try out new investment markets, and potentially score high returns. 

But due to their high-risk profile and generally high investment costs, investing in alternatives isn’t for everyone. So if you’re thinking about making a move, talk to a financial advisor before getting started.