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Alternative Assets For Average Investors

by Katrina Lamb,CFA

Alternative assets can bring significant benefits to investment portfolios through diversifying exposure away from traditional fixed-income and equity assets. Moreover, alternative assets are no longer the exclusive province of the super-wealthy; if fact, the average retail investor can avail him- or herself of a wide range of alternative asset strategies through traditional vehicles, including mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs).This article will serve as a guide to understanding different types of alternative assets and how they can be effectively used to enhance portfolio diversification.

Defining Alternative Assets

What's an alternative asset? We can perhaps start by explaining what an alternative asset is not: it is not a direct fixed-income or equity claim on the assets of an issuing entity. For example, a holder of a senior secured bond owns a claim on certain specified assets of the issuer, like residential property or farm equipment. In the event of liquidation, an issuer's secured and unsecured bondholders are paid off according to the seniority of their claims. Equity investors, by definition, own a claim on the residual net worth of the company after all its liabilities have been paid off, whether this amount is a lot or nothing at all.

Single-Asset Alternatives

Alternative assets are none of the above, which is why they are called "alternative". An example of an alternative asset is a commodity futures contract. The contract gives its owner the obligation to take delivery of some object of value, like gold or pork bellies or Japanese yen, at some specified point in the future. An option on this futures contract would confer the right (not the obligation) to exercise the contract at one or more defined times during its life or to let the option expire worthless. Options and futures are derivatives: they derive their value from an underlying source, such as gold or pork bellies.

Pooled Vehicles

In addition to single-asset instruments, the term "alternative assets" also refers to pooled investment vehicles (multiple investors' money is pooled by one manager) constructed to possess a different risk/reward matrix from traditional debt or equity investments. Pooled alternative vehicles can come in the same forms as their traditional counterparts - such as SEC-registered mutual funds or separately managed accounts (SMAs). They can also be unregistered vehicles like hedge funds, venture capital or private-equity funds. These funds typically employ a combination of securities, some standard and some alternative.

Low Correlation and Absolute Return

Alternative assets come in many varieties, but a common thread is their low correlation coefficients with both equities and fixed income.