Prolonged stock market volatility has caused many investors to question how much of their portfolios should be allocated to equities. The world of investing isn’t solely about stocks and bonds. There are alternative investments, many of which are available only to certain qualified high net worth and ultra high net worth investors, that may provide ways to diversify¹ your portfolio and potentially maximize your portfolio's risk-adjusted return.

Alternative investments can help protect purchasing power, acting as a hedge against inflation. Additionally, they tend to have very low correlations with stocks and bonds. However, it's just as important to understand that alternative investments are not for everyone as they are often speculative, involve a high degree of risk, and you can lose a substantial amount or all of your investment.

Alternative investments take many forms. Here is a look at several common investment types.

Commodities.² These investments include metals such as gold or silver, oil and agricultural products. The advantage of commodities is that they exhibit a low correlation to both equities and bonds. Consequently, when the stock market is experiencing weakness, commodities tend to hold their own. However, commodity prices are volatile, thus there is more risk. In the case of gold or silver, there are dealers who trade these precious metals. If you take physical possession of gold or silver, you will need to arrange for storage and insurance. Because many investors do not want to make these arrangements, investment vehicles such as exchange-traded funds (ETFs) are one way to access commodities.

Hedge funds.³ The term hedge fund is a catch-all phrase describing funds that often follow aggressive investment strategies such as intensive use of derivatives, selling short and proprietary computerized trading. Hedge funds typically are engineered to seek a more favorable risk-adjusted return than their investors might obtain from an investment vehicle that follows a standard market benchmark. By law, hedge funds are restricted to a low and limited number of accredited investors and are primarily organized as limited partnerships. As a result, the vast majority of hedge funds target institutions and wealthy individuals.

Private equity.⁴ Major categories of private equity include venture capital, leveraged buyouts, managed buyouts and mezzanine financing. Investors participate in private markets through collective vehicles such as partnerships that actively manage the investment assets on the investors' behalf. Once a particular partnership has reached its target size, the partnership is closed to new investors, including new funds from existing investors. Private equity firms frequently require investors to make commitments ranging from $5 million to $10 million or more. Successful investing in this area requires the ability to assess complex financial structures, assume outsized risk in pursuit of superior reward and tolerate extended periods of illiquidity.

Real estate investment trusts (REITs) and real estate.⁵ REITs invest in groups of professionally managed properties such as office buildings, apartments, warehouses or hotels. To qualify as a REIT, a company:

• Must invest at least 75% of its total assets in real estate,
• Must derive at least 75% of gross income from rents or mortgage interest, and
• Must pay at least 90% of its taxable income in the form of shareholder dividends.

• REITs trade on major exchanges and can be bought or sold as you would trade a stock.

  Another option is to invest directly in real estate, which allows you to gain total control over your investment. Decisions on leasing terms, amount to charge for rent, expenses to incur and selling price are all at your discretion.

  All investing involves risk, including loss of principal; and alternative investments by themselves can be highly volatile. But when used in combination with stocks or other assets, they may help to smooth out long-term returns and provide an alternative when stock returns are choppy.

  Which alternative investments may best complement a portfolio will depend on a number of factors, including one’s existing holdings, financial situation and appetite for risk.

  Footnotes/Disclaimers:

  ¹There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not assure a profit or protect against loss in a declining market.

  ²The commodities markets may fluctuate widely based on a variety of factors including changes in supply and demand relationships; governmental programs and policies; national and international political and economic events, war and terrorist events; changes in interest and exchange rates; trading activities in commodities and related contracts; pestilence, technological change and weather; and, the price volatility of a commodity.

  ³Hedge funds often engage in speculative investment practices that may increase the risk of investment loss. Hedge funds can be highly illiquid; are not required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; and often charge high fees.

  ⁴Investing in private equity funds carries risks such as: Liquidation Risk – they generally will invest in securities that are not readily marketable and not redeemable, therefore, investors must bear the risks of investing in a fund for its full duration; Valuation procedures are subjective in nature, do not conform to any particular industry standard and may not reflect actual values at which investments are ultimately realized; Speculative investment – the investment strategies used may include highly speculative investment techniques, highly concentrated portfolios, control and non-control positions and illiquid investments.

  ⁵In addition to the general risks associated with real estate investments, REIT investing entails other risks such as credit and interest rate risk. Real estate investment risks can include fluctuations in the value of underlying properties; defaults by borrowers or tenants; market saturation; changes in general and local economic conditions; decreases in market rates for rents; increases in competition, property taxes, capital expenditures, or operating expenses; and other economic, political or regulatory occurrences affecting the real estate industry. Many non-REIT real estate investments are illiquid and are not listed on any exchange.

  Alternative investments can be highly illiquid, are speculative and not suitable for all investors. Investing in alternative investments is only intended for experienced and sophisticated investors who are willing to bear the high economic risks associated with such an investment. Investors should carefully review and consider potential risks before investing. Certain of these risks may include loss of all or a substantial portion of the investment due to leveraging, shortselling, or other speculative practices, lack of liquidity in that there may be no secondary market for the fund and none is expected to develop, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification and resulting higher risk due to concentration of trading authority when a single advisor is utilized, absence of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds, and risks associated with the operations, personnel and processes of the manager. Individual funds will have specific risks related to their investment programs that will vary from fund to fund.
  
  The sole purpose of this document is to inform, and it in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or service, or to attract any funds or deposits. Investments mentioned in this document may not be suitable for all investors. Before making any investment, each investor should carefully consider the risks associated with the investment and make a determination based upon the investor’s own particular circumstances, that the investment is consistent with the investor’s investment objectives.
  
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