Alternative investments may help diversify your portfolio and potentially hedge against market uncertainty.

Diversification is one way to weather periods of market uncertainty. During particularly volatile or low-yield times, your investment strategy may benefit from more complex investments with returns that are separate from equity or fixed income markets.

Alternative investments tend to move counter to stock and bond markets, which may make them an effective diversification tool. Two common types of alternative investments are hedge funds and private market investments.

Before diving into specific features of each, it’s important to know what distinguishes them as an investment.

What are alternative investments?
 

A key distinguishing feature of alternative investments is they’re expected to generate an absolute return, independent of any benchmark.¹ Additionally, differences between alternative investments and traditional stock and bond investing include:

• Alternative investments are less regulated. Alternative investments are not subject to the same level of regulatory scrutiny when compared to investments such as mutual funds. Due to less regulatory oversight and the potential for higher risk, most alternative investments are only available to investors deemed as “accredited” or “qualified purchasers.” Each requires an annual income over a specific threshold over multiple years and/or a net worth over a specified level.  These products are not suitable for every investor even if the investor does meet the financial requirements.
• Alternative investments are illiquid. Private market investments often require seven-to-10-year commitments, and there’s no secondary market for these investments. Hedge funds often restrict investors from redeeming their money after the initial investment and in limited circumstances, may provide opportunities for redemption but at discounted prices.
• Alternative investments use more leverage than traditional investments. Alternative investments often utilize borrowed capital (leverage) in an attempt to enhance the return which can magnify potential losses or gains and involves a heightened category of risk for investors.
  
  

Hedge funds
 

Hedge funds are investments that use pooled funds with the goal of generating high potential returns for investors. Unlike mutual funds, hedge funds consist of assets beyond stocks and bonds. Because of the inherent risk associated with hedge funds, most are only appropriate for accredited/qualified investors, those who could withstand the total loss of value of their investment.

There are many different hedge fund strategies, and some come with more risks than others. Additionally, hedge funds aren’t tax-efficient investments, so investors should work with a financial professional to ensure the anticipated after-tax return is consistent with their financial goals.

Get more details on how hedge funds work to diversify your portfolio.

Private market investments
 

Consider private markets as the alternative investing counterpart of publicly traded stocks. Unlike stocks, however, when a business seeks private investors, only accredited/qualified individuals may invest.

Successful private market investments have historically shown the ability to outperform their public market proxies, whether it be bonds or equities.2 Investors may benefit from investing in private market funds whose investment teams are able to implement changes. Whether it be increasing revenues, cutting costs, or instituting changes among the executive decision-makers, these changes can equate to a higher valuation when the company is sold. A successful private market investor has the ability to spot funds that can turn around the fortunes of struggling companies.

There are potential advantages for investors who successfully incorporate private markets into their portfolios, but there are also associated risks, including the full loss of the investment. In addition, private markets funds are considered an illiquid investment with no secondary market, so investors should be prepared to have their money tied up for at least 10 years.

Companies seeking private investors are not required to disclose as much information as publicly traded companies, so it’s important to conduct research in advance and partner with a knowledgeable financial professional.

Typically, seeking a worthwhile investment in this area requires familiarity with a given sector. You may want to consider tapping into a network of investors and advisors to help source solid private market opportunities.

Get more details on investing in private markets.

Alternative investments and your portfolio
 

As with any investment, it’s important to consider individual alternative investments within the larger context of your portfolio strategy.

You may be looking to offset the risks you have in terms of stock and bond exposures. For example, you might consider an alternative investment with a low correlation to the stock and bond market and potentially gain access to a return stream less sensitive to market movement.

If you’re interested in entering the world of alternative investments, be sure to talk with a financial professional about which types can be an appropriate fit within your portfolio.

Read more about diversification strategies for your investment portfolio.

Diversification and asset allocation do not guarantee returns or protect against losses.

Alternative investments very often use speculative investment and trading strategies. There is no guarantee that the investment program will be successful. Alternative investments are designed only for investors who are able to tolerate the full loss of an investment. These products are not suitable for every investor even if the investor does meet the financial requirements. It is important to consult with your investment professional to determine how these investments might fit your asset allocation, risk profile and tax situation. Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund. Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable.

1 “Absolute Return.” Investopedia. April 26, 2021.

2 “Everyone now believes that private markets are better than public ones,” The Economist, January 30, 2020.