Investing Ideas

What are alternative investments? A guide for financial advisors

Discover what alternative investments are, their types, benefits, risks, and how financial advisors can integrate them into client portfolios.

What are alternative investments?

Traditional portfolio holdings include stocks, bonds, and cash/cash-like instruments. Alternative investments encompass everything else, with a broad and diverse range of asset types and investment strategies falling within the “alternatives” classification. 

Different types of alternative investment will have different risk and benefits, and financial advisors can serve a variety of investment goals when incorporating them into client portfolios. Alternative investments may help improve portfolio diversification by providing a source of returns that doesn’t rise and fall in line with the traditional stock and bond markets. In some cases, those returns have outperformed those of traditional sectors. 

Those potential return and diversification benefits have attracted growing interest among institutional and high net worth investors. With new investment vehicles emerging that make many types of alternatives more accessible, they’re becoming easier to incorporate into portfolios.

Types of alternative investments

Investments classified as alternatives may include private equity, private credit, real assets, liquid alternatives, and digital assets.

Liquid alternatives/hedge funds

  • Equity hedge
  • Relative value
  • Options-based
  • Event driven
  • Macro

Private equity

  • Generalist private equity
  • Buyout
  • Venture capital
  • Growth equity
  • Secondaries

Private credit

  • Direct lending
  • Distressed debt
  • Collateralized loan obligations
  • Mezzanine debt
  • Opportunistic credit

Real assets

  • Private real estate
  • Commodities
  • Infrastructure
  • Fine art/collectibles

Digital assets

  • Cryptocurrencies
  • Stablecoins
  • Central bank digital currencies
  • Non-fungible tokens

Private equity

Taking an ownership stake in private company. Private equity funds may seek to buy existing companies with the hope of revamping them to make them more profitable (buyout), or invest in young and/or fast-growing firms in the hope that their value will increase as the company expands (venture capital, growth equity). 

Private credit

Private credit generally provides loans to private companies that are outside the domain of public markets. 

Private real asset investments 

Private real asset investments represent ownership interests in tangible assets, such as real estate, infrastructure, and commodities.

Liquid alternatives and hedge funds

Liquid alternatives and hedge funds are investment strategies that primarily invest in public securities but utilize tools like leverage, shorting, hedging, and other sophisticated portfolio construction methods, and may produce returns that differ from those of long-only assets (i.e., aiming to outperform in a bear market, or produce steady returns regardless of the market environment). To invest in hedge funds, investors must often meet certain qualifications. Liquid alternative strategies are generally executed through ETFs and other types of investment vehicle with fewer barriers to entry.

Digital Assets (cryptocurrency)

Digital Assets (cryptocurrency) encompass crypto-related assets, such as digital currencies and digital tokens. Investable forms of these assets have recently become available as exchange-traded products (ETP).

Benefits of alternative investments 

While individual categories of alternatives have distinct characteristics and can play unique roles in a portfolio, investors have generally allocated to alternatives when seeking to enhance returns, manage risk, or improve diversification.

Expanded investment universe

Enhanced potential returns and income

Diversification


Since alternatives often include assets other than stocks and bonds, they may offer diversification benefits beyond traditional markets. This may help manage portfolio risk by incorporating assets into a portfolio whose returns aren’t correlated with public markets. Some alternative investments may also offer the potential for enhanced returns in low-yield environments. Real estate and private equity are among the most popular alternative asset classes.

Risks of alternative investments 

Selecting the appropriate alternatives allocation for client portfolios requires a careful review of investment objectives, risk tolerance, and liquidity needs.

Many alternative investments are more illiquid than traditional investments like stocks and bonds, and may be more difficult to sell quickly if an investor wishes to reallocate. Some alternatives, like certain private equity funds, may require years- or months-long lock-up periods. 

An investor’s ability to take on illiquidity is a key factor in determining their capacity to allocate to alternatives. There are two key risks that Fidelity considers: 

Spending shortfall risk
The risk that a client won’t have enough liquid assets to meet their spending needs.

Allocation drift risk
The possibility that changes in asset values will cause the portfolio’s composition to change over time, altering its risk profile, and the client won’t have sufficient liquid assets to rebalance it.

Since many alternative investments involve non-publicly traded assets or more sophisticated trading strategies, they can be more complex to evaluate and require greater due diligence. 

Many alternative investment funds or vehicles may charge higher fees compared to traditional investments. And investors may also have to meet regulatory considerations to be qualified to invest in certain types of alternatives. 

How to get started with alternative investments

Financial advisors considering incorporating alternatives into client portfolios should consider these steps:

  • Assess client objectives and risk tolerance.
  • Determine their liquidity needs.
  • Start with liquid alternatives before moving to private markets.

 

Want to learn more about alternatives? 

Read a wide array of insights to deepen your knowledge:

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Explore more on:
Alternatives Digital assets Liquid alternatives Private credit Private equity Real assets

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Alternative investment strategies may not be suitable for all investors and are not intended to be a complete investment program. Alternatives may be relatively illiquid; it may be difficult to determine the current market value of the asset; and there may be limited historical risk and return data. Costs of purchase and sale may be relatively high. A high degree of investment analysis may be required before investing.

Digital assets are highly volatile, and their market movements are very difficult to predict. Various market forces may impact their value including, but not limited to, supply and demand, investors’ faith and their willingness to purchase it using traditional currencies, investors’ expectations with respect to the rate of inflation, interest rates, currency exchange rates, an evolving legislative and regulatory environment in the U.S. and abroad, and other economic trends. Investors also face other risks, including significant and negative price swings, flash crashes, and fraud and cybersecurity risks. Digital assets may also be more susceptible to market manipulation than securities.

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