Alternative investments are different to conventional investments i.e. listed equities (stocks), bonds, and cash. Alternative investments include venture capital, private equity, private debt, hedge funds, managed futures, commodities, derivatives contracts, art and antiques and, most recently, crypto.
Figure 1: Alternative Investment – Asset Classes
The terms “traditional” and “alternative” do not imply that alternatives are uncommon or that they are relatively recent additions to the investment universe. The growth of modern alternatives took root in the early 20th century, but assets such as real estate and commodities are arguably two of the oldest types of investments. Over the past 20 years alternatives have grown significantly.
Alternative investments also include non-traditional approaches to investing within special vehicles, such as private equity funds and hedge funds. These funds may give the manager flexibility to use derivatives and leverage, to make investments in illiquid assets, and to take short positions. The assets in which these vehicles invest can include traditional assets (stocks, bonds, and cash) as well as non-traditional assets. Management of alternative investments is typically active. Alternative investments often have many of the following characteristics:
Narrow specialisation of the investment managers.
Relatively low correlation of returns with those of traditional investments.
Less regulation and less transparency than traditional investments.
Limited historical risk and return data.
Unique legal and tax considerations.
Higher fees, often including performance or incentive fees.
Concentrated portfolios.
Restrictions on redemptions (i.e., “lockups” and “gates”).
Figure 2: Investment attributes of Alternatives vs Traditional Fund Structures
Alternative investments are attractive to investors because of the potential for portfolio diversification resulting in a higher risk-adjusted return for the portfolio.
CFA, 2019 - 'Introduction to Alternatives'
World Economic Forum, 2015 - 'An Introduction to Alternative Investments'