Beginner’s guide to alternative investments: beyond stocks & bonds

Alternative investments are those that fall outside the traditional asset classes of stocks, bonds and cash. From private equity and hedge funds to property, commodities and cryptocurrency, the term encompasses a huge range of asset classes, each with their own features and benefits.

But what defines alternative investments? What advantages and disadvantages do they deliver when compared to traditional assets classes? And what role can alternative investment strategies play within a broader portfolio? Read on to explore these questions in more detail.

What are alternative investments?

Alternative investments are financial assets that aren’t stocks, bonds or cash. Alternative investments you might have come across include:

• Property – Whether it’s an investment in commercial real estate or one in residential or luxury property, this well-known alternative asset class can deliver long-term benefits (due to the increase in the value of property over time) plus regular, stable income (in the form of rent).
• Private equity – Investing in companies that aren’t publicly listed (private equity) or in a start-up with the potential to grow substantially (venture capital) both offer high return potential.
• Hedge funds – Generally unregulated, hedge fund managers combine alternative investment strategies to invest in asset classes from currencies to property, stocks and derivatives – with the goal of optimizing returns.
• Natural resources – This refers to investments in the development or production of raw materials (gold, silver and naturally-occurring substances) as well as those in agricultural products.
• Infrastructure – Often undertaken in public-private partnerships, investments in energy (particularly renewables), logistics, transport and utilities are increasingly popular.
• Art and other collectables – From art to artifacts and wine to sports memorabilia, it’s possible to turn your passion into an alternative investment that accumulates value over time – though bear in mind that some of these assets can be extremely difficult to value.
• Cryptocurrencies – Relatively new as an asset type, digital currencies such as bitcoin are an increasingly popular yet volatile investment choice.

Valued at $13.7 trillion in 2021 and set to grow to $23.3 trillion by 2027, the alternative investments market is booming in popularity – and not just amongst institutional investors, its traditional audience. According to EY, alternative investments now feature in 29% of high-net-worth (HNW) investor portfolios, with the figure rising to 81% for ultra-high-net-worth (UHNW) investors.

Unlike traditional investments, alternative investments have low or no correlation to financial markets. This means that they bring balance – known as diversification in financial terminology – to investor portfolios and provide protection (aka hedging) against inflation. As a result, they’re particularly popular during market downturns and turbulence.

What are the key characteristics of alternative investments?

While they encompass a huge range of asset types, alternative investments share certain characteristics. They’re typically low or non-market correlated, meaning that their performance isn’t impacted by stock market ebbs and flows. Plus, they can deliver significantly higher returns along with lower transaction costs.

On the flip side, most alternative investments are illiquid (meaning they’re harder to sell quickly) and often have longer investment horizons. Typically, they require higher minimum investments than traditional asset classes. And while the alternatives sector has seen vast improvements when it comes to transparency – with greater protection for investors – alternative investments are far less regulated than their traditional counterparts, often have complex structures and are generally associated with higher risks.

Traditional vs. alternative investments: What’s the difference?

Whether prioritizing traditional or alternative investments, the objective is typically to enhance returns in a manner that aligns with your risk profile. However, it’s important to be aware of the differences between investment types. We’ve summarized them below:

• Liquidity – Publicly traded stocks and bonds are easy to convert to cash, but alternative investments tend to be less liquid. What’s more, the unique nature of some alternative investments makes them difficult to value.
• Regulation – From the Financial Conduct Authority (FCA) in the UK to the US Securities and Exchange Commission (SEC), the traditional investment market is heavily regulated. The regulation of alternative investments is less clear. Alternative investment vehicles are regulated by the SEC, for example, but securities aren’t required to be registered.
• Returns – A significant advantage of alternative investments is their potential to deliver higher returns than traditional ones. Of course, in some instances, this is accompanied by complex investment structures and potentially a higher degree of risk.
• Risk –  On the one hand, alternative investments are generally seen as riskier than those within conventional asset classes, making due diligence crucial when choosing an alternative investment product. However, given that they’re uncorrelated to traditional markets, alternative investing strategies help to diversify your portfolio and hedge against inflation. As a result, they have the potential to reduce overall portfolio risk. (Discover the DFC approach to due diligence and steps we take to ensure that the alternative investments we source have robust security structures designed to mitigate risk.)
• Time horizon – Traditional investments have no set time horizon, meaning you can cash them in when it suits you. In contrast, many alternative investments tend to have longer time frames for a variety of reasons – you could be signing a contract to partner in a private equity business, for example, or waiting for property to accrue value. As a result, they’re often suited to those with longer time horizons. However, there are alternative investment opportunities with shorter time horizons. At DFC, for example, we focus on products with flexible terms to suit investor preferences and time horizons, including those that offer regular coupon payments.
• Flexibility – From property to cryptocurrency, there’s a huge variety of alternative investments to choose from – and the way that investments are structured varies widely. As a result, there’s greater flexibility and scope to find investments that align with your goals, risk profile and personal interests.
• Minimum investment – Traditional investment classes don’t have a minimum investment amount. Many alternative investments do. (We source alternative products with a minimum investment of $10,000, for example.)
• Transactions costs – Due to low turnover, alternative investments typically have lower costs than traditional ones.

What role do alternative investments have in a portfolio?

As they behave differently to traditional investments, alternative investments have a distinct place in investor portfolios. The right alternative investment strategy powers portfolio diversification and reduces overall risk – while helping achieve long-term financial growth objectives.

From capital growth to income generation, diversification and safety, different alternative asset classes perform different roles – so allocation depends on investors’ financial goals, circumstances and risk profile, as well as current market conditions.

Property investments provide a hedge against inflation, for example – as well as having the potential to generate a stable income and provide long-term growth. Meanwhile, commodities are widely held to be a safety net in turbulent markets – while investments in private equity boost returns. Alternative fixed-income bonds with a short-term horizon can provide steady returns to give longer-term investments the opportunity to outlast market turbulence.

Of course, it’s crucial to do your research and conduct due diligence before investing. However, the broad scope of the alternative investments market means there’s a wealth of strategies that enable investors to diversify and stabilize their portfolios.

Are alternative investments right for you?

Alternative investments are growing in popularity amongst retail investors – opportunities are now more accessible, with many products specifically aimed at high-net-worth individuals. Meanwhile, institutional and accredited investors continue to allocate a greater proportion of their portfolios to alternatives.

The preference for alternative investments increases with wealth – with research from EY highlighting that 14% of the mass affluent, 29% of HNW individuals and 81% of UHNW investors include alternative assets in their portfolio. Bear in mind too that wealthier investors are likely to allocate a higher proportion of their portfolio to alternative investments.

Recent research also suggests that Generation X and Millennial investors are more likely than Boomers to express interest in differentiated alternative investment strategies – those that encompass cryptocurrencies, private assets and hedge funds, for example.

How can DFC help?

Ultimately, the right alternative investments have the potential to enhance portfolio diversification and drive long-term growth, often independent of broader market volatility and the pressure of inflation. However, before committing capital, it’s crucial to understand relevant time horizons, risk factors and market dynamics of each investment – and to ensure they’re aligned with defined financial goals and risk tolerance.

At DFC, we source best-in-class opportunities across alternative private debt classes, focusing on investments characterized by flexibility, the potential for regular income streams and risk mitigation features such as insurance policies. Leveraging a rigorous screening process, we identify strategies with established track records, assessing each opportunity’s financial strength and operational integrity.