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What is an Alternative Investment?

Alternative investments represent asset classes of just about anything outside the realm of traditional stocks, bonds or cash. Many investment options fall into this category including real estate, commodities, hedge funds, private debt and private equity.

Alternative investments, or alternatives, have gained favor among financial professionals in recent years. As markets have become more unpredictable, investors have sought assets that are less correlated with the variations experienced with daily market pricing. This has advanced an allocation model with four general investment options:

  1. Traded stocks, where a company issues securities representing ownership in a company.
  2. Bonds, where a company borrows money for a specific time period at a fixed interest rate.
  3. Cash equivalents, such as actual cash or assets that can be quickly converted into cash.
  4. Alternative investments, such as real estate, commodities, hedge funds, private debt and private equity.

Large institutional investors have successfully invested in alternative investments for years. While institutions have different goals and longer investment horizons than typical individual investors, certain individuals now have the opportunity to invest in these assets.

Types of Alternatives

Asset ClassesAlternative investments can be traded and non-traded. For example, traded real estate investment trusts (REITs) and business development companies (BDCs) can be bought and sold just like stocks or bonds on public exchanges. The advantage here is that investments in traded alternatives are highly liquid.

Alternately, there is no secondary marketplace for non-traded investments — which are typically only available to qualified investors through their financial advisors — making the investment comparatively illiquid. Non-traded REITs and non-traded BDCs are two types of alternative investments. Non-traded REITs invest in real estate and real estate-related assets, while non-traded BDCs invest in the equity or debt of privately owned companies. Both offer a diversification option for the higher risk long-term investment portion of certain qualified investors' portfolios.

This graphic is not intended to be a representation of a portfolio allocation model.

  REITs BDCs
Underlying investments Real Estate Private Companies
SEC registered (public offering)
SEC reporting (public reporting)
Tax reporting on Form 1099
Distribute ≥ 90 percent of income to avoid corporate tax
Meet asset and diversification test
Comply with Sarbanes-Oxley

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