Loading the player...

What is an 'Alternative Investment'

An alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash. Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of the complex natures and limited regulations of the investments. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.

BREAKING DOWN 'Alternative Investment'

Many alternative investments have high minimum investments and fee structures compared to mutual funds and exchange-traded funds (ETFs). There is also less opportunity to publish verifiable performance data and advertise to potential investors. Most alternative assets have low liquidity compared to conventional assets. For example, investors are likely to find it considerably more difficult to sell an 80-year old bottle of wine compared to 1,000 shares of Apple, due to a limited number of buyers.

Investors may have difficulty valuing alternative investments due to transactions often being unique. For example, a seller of the extremely rare 1933 Double Eagle $20 gold coin may have difficulty determining its value, as there are only 13 known to exist as of 2016. Alternative investments are prone to investment scams and fraud due to their unregulated nature, therefore it is essential that investors conduct extensive due diligence.

Alternative Investments for Diversification and Hedging

Alternative investments typically have a low correlation with those of standard asset classes, which makes them suitable for portfolio diversification. Because of this, many large institutional funds such as pensions and private endowments have begun to allocate a small portion of their portfolios, typically less than 10%, to alternative investments such as hedge funds. Investments in hard assets such as gold and oil also provide an effective hedge against rising inflation, as they are negatively correlated with the performance of stocks and bonds.

Alternative Investment Costs and Tax Considerations

Although alternative assets may have high initial upfront investment fees, transaction costs are typically lower compared to conventional assets, due to lower levels of turnover. Alternative investments held over a long period of time may result in tax benefits, as investments held longer than 12 months are subject to a lower capital gains tax in comparison to shorter-term investments.

Accessing Alternative Investments Through ETFs

While the majority of retail investors may have limited availability to alternative investment opportunities, real estate and commodities such as precious metals are widely available. ETFs now provide ample opportunity to invest in alternative asset categories that were previously difficult and costly for the retail investor to access. Investing in ETFs that have exposure to alternative assets has been mixed. As of February 2018, the SPDR Dow Jones Global Real Estate ETF had an annualized five-year return of 4.6%, while the SPDR S&P Oil & Gas Exploration & Production ETF returned negative 7.7% for the same period. 

Regulation of Alternative Investments

Alternatives investments are often subject to a less clear legal structure than common investments but are increasingly regulated by the Dodd-Frank Wall Street Reform and Protection Act. They are still not overseen, however, as closely as mutual funds and ETFs by the Securities and Exchange Commission (SEC) and the Financial Industry Regulation Commission. Often, only those deemed "accredited investors" (those with a net worth exceeding $1 million or with a personal income of $200,000 or more per year) have access to alternative investment offerings. 

  1. Alternative Energy ETF

    An exchange-traded fund that invests in companies engaged in ...
  2. Alternative Trading System - ATS

    Alternative Trading System - ATS is a trading system that is ...
  3. Managed Futures

    An alternative investment strategy in which professional portfolio ...
  4. Alternative Fuels Tax Credit

    A non-refundable tax credit awarded to taxpayers who use non-alcohol ...
  5. Stock Exchange-Traded Fund (ETF)

    A Stock Exchange-Traded Fund (ETF) is a security that tracks ...
  6. ETF Of ETFs

    ETF of ETFs are exchange-traded funds (ETF) that track other ...
Related Articles
  1. Investing

    The Pros & Cons of Alternative Investments

    Alternative investments are becoming popular investment vehicles for individual investors.
  2. Investing

    Investment Strategy Case Study: Traditional Vs. Alternatives for 2016

    Learn more about some types of alternative investments and why you should consider adding them in your portfolio in 2016.
  3. Investing

    Should Your Retirement Portfolio Include Alternative Investments?

    Alternative investments have the potential to generate attractive returns with the added benefit of protecting a portfolio from market volatility.
  4. Financial Advisor

    Hedge Funds and Alternative Funds Are Not Evil, Here's Why

    While disclosures and investor education need improvement, alternatives provide a valuable way to increase yield and hedge against declines.
  5. Investing

    ETFs For Alternative Asset Classes

    The continued growth in ETF adoption will only help strengthen the funds structure for these assets outside of bonds and stocks.
  6. Financial Advisor

    How New SEC Rule Would Hit Alternative Mutual Funds

    New rules proposed by the SEC could require some alternative mutual funds to scale back the use of derivatives.
  7. Investing

    Are ETFs Appropriate for High Net Worth Investors?

    Take a look at some of the main reasons why exchange-traded funds (ETFs) are considered excellent investment choices for high-net-worth individuals.
  8. Investing

    Top 5 Alternative Energy ETFs for 2018

    ETFs that focus on alternative energy have not produced positive returns but these 5 show promise.
  9. Financial Advisor

    Fund and ETF Strategies for Volatile Markets

    Looking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
  10. Investing

    Top Alternative Investments for Retirement

    Diversify your retirement portfolio with alternative investments – peer-to-peer lending, precious metals, even Bitcoins.
  1. Should I offer alternative investments to my employees?

    Learn the pros and cons of employer-recommended alternative investments and why risky alternatives, such as hedge funds, ... Read Answer >>
  2. Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your ... Read Answer >>
Hot Definitions
  1. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  2. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  3. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  4. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  5. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
  6. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
Trading Center