What Are Alternative Funds and When Should You Invest in Them?

What are Alternative Investments?

People who want exposure to alternative assets seek investments outside of the traditional markets of stocks, fixed-income or cash. The goal is to create portfolio diversification.

Investing in alternative assets often requires buyers to lock up their money for five, maybe 10 years. During that time investors may not see any money distributed. Liquidity is also an issue as fund managers can’t easily buy or sell holdings like managers in traditional markets, so investors can’t easily tap those assets when they want. Alternatives Investments can open the door to enhanced investment returns and portfolio diversification.

Types of Alternative Investments

Hedge funds

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.

Private equity

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. Learn more about private equity alternative investments.

Commodities

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

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.
• 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. Learn more about REITs and other real estate investments.

How to Invest In Alternative Investments

While many alternative investments are often limited to accredited investors, institutional investors or those with high net worth, there are also options for non-accredited investors. Alternative mutual funds or ETFs are available for individual investors. Since most alternative investments are costly and difficult to invest in, these funds provide access to alternative investment categories for average investors.

Since they are publicly traded, there is a requirement for registration with the SEC and they’re regulated by the Investment Company Act of 1940. If you’re interested in investing in alternative investments, speak with your financial advisor to discover all of the options available.