Traditionally, investment portfolios have included stocks, bonds, and cash. The widely accepted MPT (Modern Portfolio Theory) expounded a mathematical framework for building a portfolio of stocks and bonds that maximizes expected return in accordance with an individual's acceptance of risk. Someone willing to accept more risk would choose a portfolio weighted toward stocks. For a risk-averse investor, the portfolio would contain more fixed-income products like bonds. The default weighting for a portfolio was long ago set at 60 percent stocks and 40 percent income. This division is notably successful over long periods, but other configurations can also be favorable.
However, investment options include other potential choices, and these alternatives are far more widely available than they were in previous decades. Average investors today can easily choose investments that once were only available for high-net-worth or institutional investors.
What are alternative investments?
In short, anything that is not a stock, bond, cash, or cash alternative is an alternative investment. Some are ancient, like collectibles and commodities, while others are remarkably new, like non-fungible tokens (NFTs) and cryptocurrency.
Other alternative categories include real estate (direct and passive investments), resources like oil and natural gas, precious metals, venture capital, and private equities or hedge funds.
Real estate is a traditional alternative.
While some time-honored alternatives like wine and collectibles have an extremely long time horizon for appreciation, and others like coins and jewelry require notable expertise, real estate is an option that is widely accessible and reliable over time. Real estate is the first introduction for many individuals who choose alternative investments. Many likely don't consider it an alternative but, instead, a crucial part of their diversification strategy. However, like other alternative assets, real estate is illiquid and not well-correlated to market performance.
Real estate investments are available in several forms. Investors can purchase assets like rental homes and commercial property to either manage personally or outsource the operations to a property manager. However, investors can also participate in real estate through REITs (Real Estate Investment Trusts), DSTs (Delaware Statutory Trusts), and real estate syndications. These co-ownership options allow investors to pursue assets beyond their individual reach and pursue the benefits of real estate investment without daily involvement.
Are alternative investments a good choice?
As with any investment, whether an alternative is appropriate for any particular investor depends on that person’s risk appetite and tolerance, timeline, and investment goals. For those seeking very high return potential and an increased risk tolerance, some alternatives like NFTs may be attractive.
For investors with a more conservative risk appetite, hedge fund strategies may offer the right balance between growth and stability. Daniel Maccarrone, Co-head of Morgan Stanley’s Global Investment Manager Analysis, suggests that hedge fund strategies are a viable option to replace both stocks and bonds, able to mitigate portfolio losses as well as enhance returns.1
While interest in alternative assets is growing, the participation by individual investors is still minimal when compared with participation by institutional investors like pension funds and endowments. However, billionaires seem to realize the importance of alternatives, with over half of their assets invested in various alternatives.2 According to wealthmanagement.com, interest in many alternatives is growing, with more than half of wealth advisors using some alternatives to seek the following performance objectives:
- Manage risk
- Protect against inflation
- Grow capital
- Generate income
- Diversify holdings
Wealthmanagement.com recently reported the results of a survey of financial advisors that noted that while even illiquid alternatives are increasingly popular, digital assets and cryptocurrency have recently begun to slide.3
For any investor, it's wise to maintain a balanced portfolio that aligns with their investment goals and risk tolerance. It’s a good idea to consult a wealth advisor or other trusted professional.
[1] https://www.morganstanley.com/articles/alternative-investments-key-themes, retrieved October 2023
[2] https://www.nasdaq.com/articles/alts-for-all%3A-the-growth-of-alternative-investments-explained, June 15, 2022, retrieved October, 2023
[3] https://www.wealthmanagement.com/alternative-investments/alternative-investments-are-increasingly-popular-tool-client-portfolios, retrieved October 2023
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
Risk tolerance is an investor’s general ability to withstand risk inherent in investing. There is no guarantee a recommended portfolio will accurately reflect your tolerance to risk.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
