Many people think of investments such as hedge fund and private equity as stand-alone asset classes that have little to do with more traditional asset classes such as stocks or bonds. However, alternatives actually represent different approaches to investing across a variety of markets, assets and strategies.
A useful way to think about alternative investments is to differentiate between "contents" and "containers." Contents can be either the assets themselves or the investment strategy employed. Currency and real estate, for example, are truly alternative assets in that they have little relation to the performance of traditional stock or bond investments. Alternative strategies often trade in the same markets as traditional investments but take a unique approach — long/short or arbitrage strategies, for instance. Either way, these "contents" (as a product of their mix of underlying risk factors) determine how the investments are expected to perform relative to traditional asset classes.
Containers are the types of vehicles in which these investments might be found, such as hedge funds, private equity funds and mutual funds, all of which are structured differently for a variety of management, liquidity, legal and regulatory reasons. These vehicles may include similar investments but can encompass varying styles and methods of investing across different markets. Hedge funds, for example, are categorized together because their goal is to mitigate (i.e.,"hedge out") certain risks that are inherent in traditional asset classes, and their focus is on producing returns that are less correlated with the equity and fixed income markets — not because their "contents" are all the same.
Thinking in terms of contents and containers can help you diversify your portfolio not only by investment type, but by investment vehicle. Through the various contents, you can diversify the forms of risk in your portfolio and gain exposure to different areas of the market. Meanwhile, the different "containers" can be a useful way to think about investing for different needs (e.g., liquidity needs, transparency needs, ease of access, etc.).
Understanding the Range of Investment Choices
Due to a number of product innovations, alternative investments today come in a variety of packages, span a range of strategies and are available to nearly all investors. Adding alternative investments to a traditional portfolio has the potential to enhance returns, while also reducing risk, because they don't typically move in tandem with other parts of a portfolio. The information below is designed to help you weigh some important factors when selecting individual investments.