In this section, we explain what alternative investments are and why assets under management in alternative investments have grown in recent decades. We also explain how alternative investments differ from traditional investments, and we examine their perceived investment merit. We conclude this section with a brief overview of the various categories of alternative investments; these categories will be explored further in later sections.
“Alternative investments” is a label for a disparate group of investments that are distinguished from long-only, publicly traded investments in stocks, bonds, and cash (often referred to as traditional investments). The terms “traditional” and “alternative” should not imply that alternatives are necessarily uncommon or that they are relatively recent additions to the investment universe. Alternative investments include such assets as real estate and commodities, which are arguably two of the oldest types of investments.
Alternative investments also include non-traditional approaches to investing within special vehicles, such as private equity funds and hedge funds. These funds may give the manager flexibility to use derivatives and leverage, to make investments in illiquid assets, and to take short positions. The assets in which these vehicles invest can include traditional assets (stocks, bonds, and cash) as well as less traditional assets. Management of alternative investments is typically active. Alternative investments often have many of the following characteristics:
- Narrow specialization of the investment managers
- Relatively low correlation of returns with those of traditional investments
- Less regulation and less transparency than traditional investments
- Limited historical risk and return data
- Unique legal and tax considerations
- Higher fees, often including performance or incentive fees
- Concentrated portfolios
- Restrictions on redemptions (i.e., “lockups” and “gates”)