DEFINITION of 'Alternative Investment'

An investment that is not one of the three traditional asset types (stocks, bonds and
cash). Most alternative investment assets are held by institutional investors or
accredited, high-net-worth individuals because of their complex nature, limited
regulations and relative lack of liquidity. Alternative investments include hedge
funds, managed futures, real estate, commodities and derivatives contracts.

BREAKING DOWN 'Alternative Investment'

Many alternative investments also have high minimum investments and fee
structures compared to mutual funds and ETFs. While they are subject to less
regulation, they also have less opportunity to publish verifiable performance data
and advertise to potential investors.
Alternative investments are favored mainly because their returns have a low
correlation with those of standard asset classes. Because of this, many large
institutional funds such as pensions and private endowments have begun to allocate
a small portion (typically less than 10%) of their portfolios to alternative
investments such as hedge funds.
While the small investor may be shut out of some alternative investment
opportunities, real estate and commodities such as precious metals are widely
available.
An alternative asset is a newer type of asset that has not been traditionally
considered part of an investment portfolio. Historically, examples include real
estate, commodities, as well as rare coins and stamps, artwork or trading cards.
More recently, the term has also come to be used to refer to other institutional asset
classes including private equity, venture capital, trading strategy indices, and hedge
funds.[1] Due to the nature of these assets, an accurate valuation is sometimes
difficult to accomplish.
What Is It?

Broadly speaking, an alternative investment is any investment other than the

traditional investments such as publicly-traded stocks, bonds and mutual funds.

The actual definition of alternative investment varies among financial institutions

and investors, but it generally includes hedge funds, real estate, venture capital and
derivatives. Many financial institutions that facilitate these investments conduct
frequent reviews and analyses to determine whether they need to increase their list
of alternative investment offerings. Therefore, if your financial institution does not
allow the type of investment in which you are interested today, you should check
back at a later date because things may change.

Gauging the Risk

Limiting Losses
Investment professionals typically limit their recommendations for alternative
investments to accredited investors because these investors tend to have a higher
risk tolerance. Even so, professionals usually recommend that investments in such
assets be limited to no more than 10% of the investor\'s portfolio. This restriction
helps to ensure that any losses are limited, while allowing the investor to share in
any profits.
Liquidity

Alternative assets are generally viewed as less liquid than regular assets. For example, most
artwork, sports cards, and stamps gain the majority of their value over a long period of time.
Other alternative assets, such as investments in infrastructure-related projects, may take decades
to gain significant value. Therefore, investors considering alternative assets are generally
investing far into the future.[2]
Advantages

The main advantage of alternative assets is that they help diversify an investor's portfolio. Since
they are non-traditional investments, they do not tend to move in the direction of the stock
market and may, therefore, help a portfolio sustain market volatility. Also, due to lower liquidity,
alternative assets are often mispriced and so offer opportunities for arbitrage.
Disadvantages

Due to its non-traditional nature, alternative assets are more difficult to add to a portfolio.
Therefore, banks may charge an additional fee for holding the asset. Furthermore, depending on
the returns realized from the asset, additional tax forms may have to be filed. Its lack of liquidity

is also seen as a major disadvantage since liquidating, as well as properly valuing, the asset may
take some time.