An alternative asset is an investment that does not conform to the traditional asset classes of stock, bond, or certificate. An alternative asset is usually used to describe more exotic investment options like works of art or bottles of fine wine, but the term applies to relatively common investments like residential rental real estate, as well. Due to the unconventional nature and questionable liquidity of some alternative assets, valuing an investor’s holdings can be difficult.
Breaking down an Alternative Asset
Alternative investments include antiques, precious metals, rare stamps, coins, sports cards, and other collectibles, in addition to private shares in startups, commodity pools, over-the-counter contracts, and so on. Essentially, an alternative investment is anything that you wouldn't hear a financial advisor at a bank steer a client toward. These investments are not considered mainstream and, as such, are not easily managed as part of a traditional investment portfolio.
Two Types of Alternative Assets
Alternative assets fall into two broad categories: things people collect and high finance. The things people collect covers all the physical assets like wine and rental properties where the long game is appreciation over time. Real estate should probably be in a class of its own, as it can be a business in some cases and an investment in others, but it shares some qualities with the collectible classification. These alternative assets are illiquid for the most part, and they are hard to price until equivalents sell.
Without a sale, it is hard to gauge the supply and demand of the market. There is no central exchange pegging the value of a first edition of "The Amazing Spider-Man" or a mint-condition Honus Wagner trading card on a daily basis, so the value of your collectibles will have to be guesstimated using trade publications and previous sales data—and even then, the market can swing wildly if a collectible is found to be less rare than originally thought. Generally speaking, these types of alternative assets are traded by people with a passion for them beyond the profit motive. If you are an art collector, for example, you might not be making all your decisions based on ROI projections.
The Journey from Alternative Asset to Mainstream
The second category, high finance, covers all the types of investments that were once only open to sophisticated investors and people with a lot of cash on hand. Shares of private equity and hedge funds, for example, were once limited through the exemptions they used, namely 3C7 and 3C1. However, the rise of mutual funds and funds of funds gives retail investors exposure to alternative assets they could never touch as individuals. There is no greater testament to the fact that alternative assets slowly move into the mainstream than the term “publicly traded hedge fund.”