equities

Alternative investments is a broad label, and its meaning depends on who is using it. Most commonly it refers to investments outside the traditional categories of publicly traded stocks, bonds, and cash. The label describes what an investment is not, rather than what it is, and that is the first thing to understand about it. This article is educational only; it is not investment advice, and nothing here is a recommendation of any investment or category.

Investments sometimes grouped under the label include real assets such as property or commodities, private funds, and currency-related strategies, including the Forex managed accounts and hedge funds discussed elsewhere on this site. No such list is complete, and inclusion under the label says little by itself: the investments grouped this way differ enormously from one another.

They differ in the dimensions that matter. Risk varies by investment, not by label. Liquidity varies: some alternatives trade readily, while others are difficult or slow to sell. Valuation varies: assets that do not trade on public markets can be hard to price, and stated values may rest on estimates. Complexity and fees vary as well, and complex or illiquid products can carry risks that are harder to see in advance.

Correlation deserves particular care. Alternatives are often discussed in connection with diversification because some of them have, at times, moved differently from traditional markets. But correlation is a measured, changing property of specific investments over specific periods, not a fixed attribute of a category. An investment’s past correlation with other markets may not persist, and relationships between markets can shift. Neither the alternative label nor a low correlation measured in the past assures diversification or any particular return.

Whether adding any investment actually diversifies a portfolio depends on the positions the portfolio already holds, their concentrations and correlations, and the strategy being pursued, and all investments involve risk, including the possible loss of the amount invested. How any of this applies to a particular portfolio is a judgment each investor must make independently, ideally with a qualified professional. Trading foreign exchange involves substantial risk of loss and is not suitable for every investor.

Related articles on this site cover the Forex market, correlation, the Sharpe ratio, managed accounts and hedge funds, and how to evaluate a manager’s track record.