Alternative Investments are a broad category of assets that fall outside the traditional investment buckets of stocks, bonds, and cash. Think of them as the roads less traveled in the investment world. While your typical portfolio might be built on shares of public companies and government or corporate debt, alternatives encompass a wonderfully diverse and sometimes exotic universe of assets. This includes tangible things you can touch, like Real Estate and gold, as well as complex financial instruments like Hedge Funds and Private Equity. The main allure of “alts” is their potential to behave differently from the mainstream market, offering a powerful dose of Diversification and, in some cases, the prospect of higher returns. However, this potential often comes with its own unique set of rules, risks, and complexities, making them a fascinating but challenging area for the everyday investor.
For many investors, sticking to stocks and bonds is perfectly fine. But adding alternatives to the mix can be like adding a new spice to a familiar recipe—it can enhance the final result in several ways.
The holy grail of portfolio management is finding assets that don't all move in the same direction at the same time. This concept is known as Correlation. Alternative investments often have a low correlation to public stock and bond markets. When the S&P 500 takes a nosedive, an investment in a commercial office building or a private tech company might hold its value or even appreciate. This can help smooth out your portfolio's returns over time, protecting you from the full force of a market downturn. It’s about not putting all your financial eggs in one stock market basket.
Many alternatives, particularly private equity and venture capital, offer the potential for blockbuster returns that are hard to find in public markets. This is partly because investors are compensated for taking on extra risk and for tying up their money for long periods—a concept known as the Illiquidity Premium. By investing in a young company before it goes public, you could theoretically see exponential growth that public market investors miss. Of course, the risk of losing everything is also significantly higher. Some alternatives, like certain commodities and real estate, can also serve as an excellent hedge against Inflation, as their prices tend to rise when the value of money falls.
The “alternative” label covers a vast and varied territory. Here are some of the most common destinations.
This is likely the most familiar alternative. Beyond your own home, investment real estate includes rental properties, commercial buildings (offices, retail spaces), and even raw land. It's a tangible asset that can generate a steady stream of rental income and has the potential for long-term appreciation. For those who don't want the hassle of being a landlord, REITs (Real Estate Investment Trusts) offer a way to invest in a portfolio of properties by buying shares on a Stock Exchange, just like a stock.
This involves investing directly in companies that are not publicly traded. There are two main flavors:
These are private investment pools for wealthy investors that use a wide array of complex strategies to try and generate returns in any market environment. They might use Short Selling (betting a stock's price will fall), derivatives, and heavy leverage. Their exclusive nature and often opaque strategies make them difficult for average investors to access or understand. They are also famous for their high fees, often following a “2 and 20” structure (a 2% management fee and 20% of profits).
These are the raw materials that fuel the global economy. Think of:
Investors rarely buy and store barrels of oil in their garage. Instead, they gain exposure through futures contracts, exchange-traded funds (ETFs), or by investing in the shares of companies that produce these commodities.
This is the most eclectic corner of the alternative universe, including fine art, classic cars, rare wine, watches, and even Cryptocurrency. These markets are often driven by passion, scarcity, and specific expertise. They are highly illiquid, unregulated, and valuing them is more of an art than a science. For most, these should be considered hobbies first and investments second.
So, what does a value investor make of all this? The philosophy of buying assets for less than their Intrinsic Value can absolutely be applied, but it requires extreme caution. Warren Buffett, the patriarch of value investing, is famously skeptical of certain alternatives, particularly gold. His logic is simple: a bar of gold is a non-productive asset. It will sit in a vault forever, producing nothing. He would much rather own a productive business that generates cash flow year after year. However, a value mindset is crucial when navigating alternatives. It means:
Before diving in, it's vital to understand the trade-offs. The potential rewards of alternatives are balanced by significant risks.