U.S. stocks in recent years. However, “Alternative assets are not correlated to stocks or bonds, so they might move up when traditional markets are down. Johnson says.
According to Chen, alternative investments fall into two broad categories:
Alternative markets. This category includes asset classes other than stocks, bonds, money markets, and cash equivalents, which are considered traditional investments. Funds holding traditional investments fall into the “traditional” basket while funds holding nontraditional assets are in the alternative markets category.
With some alternatives, you can get direct access to commodities such as oil and gold. Other asset classes such as currencies and investment real estate may provide welcome relief when mainstream holdings fall from favor. Real estate, for example, wasn’t much help this year but it did bolster portfolios during the last bear market, from 2000 through 2002.
Astute advisers. This category includes investment vehicles that do not rely upon the success of a particular asset class. Instead, a skilled manager can make money for investors in up, down, or sideways markets. With the market-based alternative assets mentioned above, investment success depends on the price of oil, say, or the demand for investment property. Hedge funds are different—they can make money in any economic environment, depending on how well the fund is managed. “Traditional asset classes such as stocks and bonds do not have the ability to add as much alpha as hedge funds do,” says Chen, referring to the added return a shrewd strategy can generate.
To illustrate the difference between alternative markets and astute advisers, a commodities index fund will make money if the prices of commodities go up. A hedge fund, though, can make money even if commodities prices go down, as long as the hedge fund manager is smart enough to short commodity futures or hold put options on those futures.
Just as investing in one stock is risky, investing in one commodity may deliver unwelcome results. The price of oil, for example, plunged from $147 a barrel in July to $115 in August, a 22% drop in less than a month. Some advisers, therefore, prefer to get exposure oil to via a more diversified commodities play. “For some clients, we recommend a small (less than 6%) allocation to iPath Dow Jones-AIG Commodity Index Total Return (DJP),” says Lee Baker, a certified financial