In times of market or economic uncertainty, investors may turn to alternative investments as a way to mitigate volatility and potentially improve risk-adjusted returns.
While alts come with risks of their own, these investments are not typically correlated with traditional stock and bond markets and can thus offer investors portfolio diversification.
In addition, alternative investments — an umbrella term for assets that fall outside standard stock, bond, and cash options — used to be accessible only to high net-worth and accredited investors. Now alts are available to a range of investors thanks to the emergence of new vehicles that include different types of alternative strategies and assets.
Key Points
• Alternative investments are not generally correlated with traditional stock and bond markets, so they can help diversify a portfolio and mitigate risk.
• Alternative investments may deliver higher returns when compared with conventional assets, but are also considered higher risk.
• Some alternative investments, including some funds that invest in these assets, may provide passive income through dividends.
• Alternative investments are typically less liquid and less transparent than conventional securities, so there can be limits on redemption, lack of data, and higher risk.
• Alternative investments may be suitable for investors who have a higher risk tolerance, are looking for diversification, and understand the potential advantages and disadvantages of these investments.
Why Consider Alternative Investments?
Not only are alternative strategies more accessible to ordinary investors today, they offer several ways to add diversification to investors’ portfolios. Alternative investments come with risks of their own (see “Important Considerations” below), and investors need to weigh the potential upside of different alts with their disadvantages.
Unique Investment Options
For investors seeking diversification — or otherwise drawn to invest in a wider range of opportunities — the world of alts offers a number of options.
Alts include tangible assets like commodities, farmland, renewable energy, and real estate. Alternatives also include art and antiques, as well as other collectibles (e.g. antiquarian books, vinyl LPs, toys, comics, and more).
In addition, alternative investments can refer to strategies like investing in private equity, private credit, hedge funds, derivatives, and venture capital. These vehicles may deliver higher returns when compared with conventional assets, but they are typically considered higher risk, owing to their use of leverage and short strategies and other factors.
Diversification
Investors wondering why to invest in alternatives often focus on diversification. Why does diversification matter? As many investors saw in 2021-22, volatility in the equity markets can take a bite out of your portfolio, as can interest rate risk.
In order to mitigate those risks, adding alternatives to your asset allocation provides a literal alternative to conventional markets, because for the most part these assets don’t move in tandem with the stock or bond markets.
In a general sense, diversification is like taking the age-old advice of not putting all your eggs in one basket. An investor can’t avoid risk entirely, but diversifying their investments can help mitigate the risk that one asset class poses.
However, the challenge with alts is that there are no guarantees of how an alternative asset might perform. And because these assets are generally less liquid and not as highly regulated as most other securities, i.e. stocks, bonds, mutual funds, and exchange-traded funds (ETFs), there can be limits on redemption — and a limited understanding of real-time pricing.
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The Role of Alts in Your Portfolio
Taking all that into account, what could be the role of alts in your portfolio? In other words, why invest in alts? Of course, alternatives would only be part of your asset allocation. How much to put into alts would depend on your risk tolerance and overall goals. Here are some factors to consider.
Low Correlation With Stocks
As noted above, most alternative strategies are uncorrelated with conventional stock and bond markets. During periods of volatility or uncertainty in these markets, some investors may find alternative investments more appealing.
That doesn’t mean that alternatives will always outperform bonds or equities. Low correlation means that a particular asset class moves in a different direction than conventional markets. So, if the stock market drops, uncorrelated asset classes like commodities or real estate and investment properties are less likely to experience a downturn — which can help mitigate losses overall.
The challenge with alts is that some of these assets come with their own intrinsic forms of volatility (e.g. commodities, renewables, private equity, venture capital), and investors need to keep these risk factors in mind as well.
Tax Treatment of Alts
Generally speaking, investment gains are taxed according to capital gains tax rules. This isn’t always the case with alternative investments. It may be a good idea to consult with a tax professional because alts don’t necessarily lower your investment taxes, but they are taxed in different ways.
Important Considerations When Choosing Alternative Investments
Investing in alts requires careful thought because these assets aren’t traded or regulated the same way as more conventional securities.
Liquidity
Generally speaking, most alts are illiquid compared with conventional assets. This can make them hard to evaluate in terms of price and hard to trade. In addition to which, there can be limits on redemption, depending on the asset. Some alts only allow redemptions twice a year, or quarterly.
Lack of Data
Owing to the lack of regulation in some sectors, it can be difficult to obtain accurate price history and trading data for some alts. This also adds to the challenge of trading some of these assets.
Who Should Invest in Alts?
Although some alternatives can be highly risky and expensive, retail investors may want to consider alts because of the advantages these assets offer in terms of diversification and risk mitigation.
The investors who decide to invest in alts today may be drawn to the number of options available via mutual funds and ETFs, many of them offered by well-established asset managers. And in some cases, including alts in a portfolio may capture some of the desired advantages.
That said, investors need to do their due diligence to understand the potential pros and cons of these instruments.
The Takeaway
Alternative investments are on the radar of many investors today because these assets may offer some portfolio diversification, help to tamp down certain risks, and possibly improve risk-adjusted returns. In addition, the sheer scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals.
That said, unlike more conventional investments, alts tend to be higher risk, more expensive, and subject to complex tax treatment. Thus it’s important to do your due diligence on any investment option in order to make the best purchasing decisions and reduce risk.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
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An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
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