Alternative investments are investments or investment strategies other than buying and selling stocks and bonds. Typical strategies include private equity, leveraged buy-out (LBO) funds, arbitrage strategies, hedge strategies, trend or event driven strategies, real estate and venture capital. Any investment that matches the benefit profile typical to alternative investments could be included! Most alternative investments include elements of both qualitative and quantitative decision making strategies.

Alternative investments do have drawbacks, though, including potential one time losses from rare events and high management fees.

What are the benefits?

Performance
The performance of alternative investments has usually exceeded that of more traditional investments in stocks and bonds over the last 10-15 years. In that period, hedge funds, a headline indicator of alternative investment strategies, have consistently outperformed US stocks. In fact, due to the direction-agnostic nature of alternative investments, they can benefit in both rising and falling stock markets.

The risk profile of alternative investments has traditionally been very different, with a low and manageable risk profile (volatility), except for occasional extreme events. More recently, businesses like Enron have shown that conventional investments can have extreme probability outlier events as well.

Non-Correlation
As alternative investments are direction-agnostic, it does not matter whether the market goes up or down. So when your stock portfolio is diving, the chances are that your alternative investments are doing fine. The non-correlated nature of alternative investments fits well with the core of modern portfolio theory: that a group of non-correlated, positive yielding investments statistically offers better risk-adjusted returns than the individual investment components.

In practical terms, non-correlation simply means that it is unlikely that all your investments will decline at the same time. With recent stock market history amply illustrating the ability of markets to decline dramatically, alternative investments have become increasingly popular.

Diversification
Typically, a conventional asset manager will diversify within conventional asset classes... which are mainly subject to the same external forces. Only by diversifying into different asset classes, can the full benefits of diversification be achieved.

We recommend only up to one third of your assets should be invested in alternative investments, with no more 5-15% being devoted to any one class. Such a diversified portfolio could have a substantially higher rate of return over time, and a significantly lower decline during drawdowns, than a portfolio without an alternative investment component.

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