Alternative investments have become increasingly popular within the investment community over the last decade as previously inaccessible parts of the market have become more available to non-institutional investors. Alternatives can be defined simply as investments that fall outside the scope of traditional stocks and bonds. Some more commonly known segments in this space include private equity, venture capital, hedge funds, private credit, real estate and commodities. These investments exhibit specific risk/reward characteristics, and an understanding of these dynamics can be daunting for even skilled investors. We note that alternatives investments are complex products that may not be suitable for all investors, and are intended for sophisticated, accredited investors who can accept the risks associated with these investments.

From a risk perspective, most of these investments are less transparent than those in the public markets and will possess idiosyncratic risks related to the manager of the specific strategy. In addition, many alternative investments are illiquid (i.e., cannot easily or readily be sold or exchanged for cash) and can involve complicated tax reporting.

On the other hand, alternatives can provide additional diversification benefits, such as lower volatility, for a portfolio because many have lower, or even no, correlation to the public equity or fixed income markets. However, diversification may not protect against market risk or loss of principal nor eliminate volatility of returns. In addition, alternatives can potentially offer higher returns or more cash yield (and in certain cases both) than expectations for the public markets.

Within this space, manager selection is essential as the difference between top and bottom quartile managers has ranged from 10-20% over the past 10 years ending December of 2024, according to a JP Morgan study (data are based on availability as of February 28, 2025). Deal sourcing is a critical step in this selection process. Unlike the public markets where all investors can compete to gain exposure to an investment, alternative investments commonly have limited capacity, and the access to opportunities is more relationship driven. A thorough due diligence process needs to be undertaken to help understand the underlying economic drivers of the opportunity, the experience of the manager, and the structural alignment of incentives for both the manager and investors. As more opportunities are seen, an investor can learn to delineate differences, uncover unique strategies, and identify the riskier deals to avoid.

Alternatives can add value to many investment portfolios. They can help to reduce certain risk while availing the potential for higher returns. Identifying appropriate opportunities in which to participate takes time, as well as having the willingness to accept some of the unique challenges associated with investments in this space, but the benefits of alternatives can be a meaningful addition to one’s portfolio.