What are Alternative Investments?
Alternative investments provide unique risk and return properties not found easily
in traditional stock and bond investments. Portfolios of conventional, publicly
traded stocks and bonds can also qualify as alternative investments if they are
constructed and managed in nontraditional ways. Although they have many unique characteristics,
alternative investments can be defined at a basic level by their ability to utilize
a wide array of trading techniques often (but not always) including selling securities
"short" and employing leverage.
Q. What are some examples of alternative investments?
A. Hedge funds, managed futures, venture capital, private equity, and leveraged
buyouts are generally accepted as being alternative investments, as are farmland,
timberland and oil and gas. Some investment professionals also include real estate
in the alternative investments category.
Q. Are there special risks associated with alternative investments?
A. Yes. Alternative investment products, including hedge funds and managed futures,
have unique risks that should be understood
prior to investing. Although every investment is unique, in general, investors
should be aware that these investments often engage in leveraging and other speculative
investment practices that may increase the risk of investment loss. They can also
be highly illiquid, are not required to provide periodic pricing or valuation information
to investors, and may involve complex tax structures and delays in distributing
important information. Alternative investments are often not subject to the same
regulatory requirements as, say, mutual funds, and often charge high fees that may
potentially offset trading profits when they occur. In addition to these general
risks, there are other more specific risks to be considered, many of which can be
found in the specific offering materials or disclosure documents for the investments
in question.
Q. What is the appeal of adding alternative investments to a portfolio?
A. Although these investments do carry their own unique risks, there are many reasons
why suitable investors may decide to add alternative investments to their portfolio.
For example, managed futures and hedge funds in particular have historically proven
to have low correlation with overall market activity.¹ Investments such as
these, tend to be good candidates to aid portfolio diversification. Portfolio diversification
is one of the key elements of Modern Portfolio Theory, and can result in portfolios
with more favorable risk versus return characteristics. There is no guarantee that
the addition of alternative investments to a portfolio will increase returns or
avoid losses.
Frequently Asked Questions about Hedge
Funds
Frequently Asked Questions about
Managed Futures
1. Dr. John Lintner, "The Potential Role of Managed Futures Accounts in Portfolios
of Stocks and Bonds.", 1983, and "Implications of the Growth of Hedge Funds," S.E.C.,
2003. Correlations may change over time.