Al·ter·na·tive In·vest·ments (noun.)
One way to define alternative investments is by what they are not - traditional stocks, bonds and real estate. In fact, they include a very wide range of diverse assets. Alternatives can be grouped into 3 broad categories:
- Hard assets: Farmland, timberland and oil & gas wells are good examples that are familiar to most, but this group also includes unique real estate such as emerging market properties and even collectables such as art, wine, coins and musical instruments.
- Businesses: A passive investment in a business such as a share in a retail store, factory, Internet start-up or even a film project. These are typically referred to as private equity or venture capital deals.
- Trading Programs: This group normally gets referred to as "hedge funds" or its popular subset, managed futures programs. Hedge funds are very different from the last two types in that they are really an investment in a manager who is making trades, not a fund that owns physical things or businesses. The items traded vary widely but most utilize commodity and futures contracts, stocks, bonds or options.
The term "hedge fund" can be a bit confusing. It generally refers to the last group of trading programs but it many times is used very loosely to cover almost any type of alternative asset. In any case, keep in mind that the word "hedge" is a misnomer. Hedging your portfolio is not necessarily the primary goal of these programs but is hopefully a welcome byproduct. The reasons for investing in alternative investments can be any or all of the following:
- a tool to reduce overall portfolio risk through diversification (the hedge part);
- an opportunity to capture potentially high rates of return;
- or simply an investment that seeks to take advantage of opportunities outside the realms of traditional stocks, bonds and common real estate.