An alternative investment 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 higher risk profile, complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.
Many alternative investments also have high minimum investments and fee structures compared to mutual funds and exchange-traded funds (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 historically 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.