Alternative investments 101: A guide to alts

Turn on a business news channel or look at the homepage of a finance publication, and there's a good chance you'll see commentary on the stock market. And if not stocks, they're probably discussing what's happening in the bond market. 

But there's much more to the investment world than publicly traded, traditional asset classes. 

Other types of assets known as alternative investments also exist. These assets may be more complex, less liquid, and aren't always as straightforward as traditional investments, but they may provide diversification and the potential for outsized returns in some cases.

What are alternative investments?

Alternative investments are assets that fall outside of the mainstream investment world. Definitions can vary slightly, but typically that means anything that's not a publicly traded stock, bond or cash/cash-like instrument.¹

Because alternative investments differ from mainstream ones, they may be exposed to different factors that affect risk and returns. Depending on the specific asset, that may mean an alternative investment has higher upside but more risk than a traditional investment, or it might mean that the asset is designed to hedge against traditional risks, among other nuances. In general, alternative investments tend to be less liquid and more complex than traditional investments. As such, they are often held by institutional investors or individual accredited investors that have the wealth and/or expertise to potentially take on more risk and navigate assets that may be less transparent than traditional ones. That said, retail investors are increasingly gaining access to alternatives, such as through ETFs that can provide exposure in various ways, like holding a mix of private and public stocks.¹

7 types of alternative investments

Alternative investments are sometimes considered an asset class as a whole — e.g., an investment strategy could include having an alts bucket to complement a traditional investment portfolio of stocks and bonds. Others, however, seek out specific types of alternative investments and consider these to be different types of asset classes, depending on their goals and perspective.

Either way, some examples of common types of alternative investments include the following:

1. Hedge funds. While these funds often trade public stocks, they're considered alternative investments because of the freedom these funds have to engage in practices like short selling (i.e., betting or hedging that stocks will fall) as well as investing in the private market and other asset classes. These alternative funds are generally only open to an accredited investor (or may require higher investment qualifications depending on their structures) and often have high investment minimums.²
    
2. Private equity/venture capital. Private equity is another type of alternative investment that includes privately owned companies as opposed to publicly traded stocks. Private equity is the broader category of private stock investing that includes areas like venture capital (VC). Basically, any ownership stake in a privately held company is considered to be private equity, although investors often separate private equity and venture capital into distinct categories: private equity often involves whole or controlling stakes in mature private companies, while VC often involves minority stakes in early-stage companies.³
   
   While some alternative investors allocate to private equity funds or private equity, these funds aren't always accessible to individuals. Instead, accredited individuals may be able to buy private company stock through a secondary marketplace like Forge, subject to share availability and eligibility requirements.
    
3. Private debt. This alternative asset class is similar to private equity but involves buying debt or loaning money privately, rather than buying equity stakes. However, this differs from buying public bonds, which are generally traded on an open market. Private debt "loans are usually highly negotiated and transacted directly between a borrower and a non-bank direct lender and are not publicly traded," explains CalPERS.⁴
   
   While institutional investors might work out their own deals, individuals might be able to access this asset class, too, via online lending marketplaces.
    
4. Real assets. This category of alternative investments can include areas like real estate and infrastructure. The structure of these investments can differ, such as with some institutional investors allocating to a real estate fund, whereas an individual might buy an investment property directly, for example.⁵
    
5. Commodities. This broad category includes assets like gold, coffee and crude oil. Basically, when you're trading a type of good that's interchangeable with others in the same category (an ounce of gold held in one vault is generally the same as an ounce of gold held elsewhere), that's a commodity. In contrast, an acre of land in one state isn't necessarily equal to an acre of land in another.⁶
   
   While commodity markets can be public and are relatively accessible to all, commodities are generally considered to be alternative investments, as they may have a low correlation with traditional investments like stocks and may have more volatility, for instance, depending on the situation.⁷
    
6. Collectibles. Unlike commodities, collectibles are goods valued for their uniqueness. Some investors put money into alternative investments like rare wine, jewelry or other types of collectible items. These markets often lack the liquidity of traditional investments like stocks, and they can be volatile as trends come and go, but some investors may benefit from selling collectibles after a period of price appreciation.⁸
    
7. Derivatives. This broad category includes financial instruments whose value is derived from an underlying asset or benchmark, such as options, futures, forwards and credit default swaps. For example, with a credit default swap, the buyer essentially purchases protection in the event of a default on the underlying credit obligation.⁹
   
   Derivatives can be complex, but they may offer investors unique ways to manage risk or gain exposure to certain markets that might otherwise be difficult to access. Some investors, like institutions, might allocate directly to derivatives through over-the-counter trades, while others might gain exposure via exchange-traded securities, though much depends on the derivatives in question.¹⁰

How do alternative investments differ from traditional investments?

The difference between alternative investments and traditional investments isn't just the split in terms of the aforementioned asset classes, with traditional investments generally encompassing public stocks, bonds and cash. They also differ in areas like objectives, complexity and risk.

The goal of allocating to alternative assets is often to provide uncorrelated returns to traditional investments and/or to increase return potential.¹¹

So, if the public stock market falls, for example, certain alternative investment funds like hedge funds could possibly rise, due to these funds short selling public stocks. Additionally, some private equity investments may hold up better than public stocks during rocky periods, since private investments aren't subject to the same quarterly earnings scrutiny that could drag down public stocks. The opposite can also be true, where alternatives fall as traditional investments rise, but this lack of correlation is what some investors seek for diversification purposes.

Alternatives also strive to provide outsized potential returns. Investing in private market companies may provide the possibility for faster growth as a company goes from a small startup to a large IPO candidate. However, alternative investments are often more complex and carry more risk, such as illiquidity, than traditional investments, though it depends on the situation. Alternative investments can also come with higher fees than traditional investments.¹¹

Benefits and risks of alternative investments

Adding alternative investments to a portfolio may offer distinct advantages, including diversification. Because alternative assets often have a lower correlation to public stock and bond markets, they might help cushion a portfolio during periods of market volatility. Certain alternatives, such as private equity and venture capital, also offer the potential for outsized returns compared to traditional investments.¹¹

However, these potential benefits come with notable potential risks. Some types of alternative investments are generally less liquid than public stocks, meaning investors may face lock-up periods or difficulty selling their holdings quickly. They can also carry higher fees and involve complex valuation methods. Investors should carefully weigh these factors and consider their individual risk tolerance before allocating capital to alternative assets.¹¹

How to invest in alternative investments

Historically, accessing alternative investments was largely restricted to institutional investors and ultra-high-net-worth individuals. Today, the landscape has evolved, offering more pathways for participation, such as through specialized funds, direct investments in real estate or commodities, and online marketplaces.¹¹ A global study by Brookfield Private Wealth found that 73% of wealth managers "say client conversations evolved from what alts are to which ones may be suitable for their portfolio goals."¹²

For those interested in private equity/venture capital specifically, accredited investors may buy and sell private company shares through a private marketplace such as Forge, subject to availability and applicable eligibility criteria. Forge's marketplace provides real-time pricing transparency via live order book data and Forge Price^TM — a derived, indicative price, calculated daily for approximately 200 pre-IPO venture-backed late-stage companies, based on synthesized data from various sources, including secondary market transactions, recent funding rounds and indications of interest on the Forge platform. Our experienced team of private market specialists is available to assist throughout the trade lifecycle. Create an account today to explore private market opportunities.