As investors seek higher yields and more stable returns while trying to limit their risk, they’re constantly looking for new investment options. A recent Morningstar report shows that “alternative investments” are growing in popularity with institutions, advisers and individual investors. These investments are often in mutual funds and exchange-traded funds and can run the gamut from real estate and commodities to hedging strategies and the use of derivatives.
Although these strategies and funds may have a small place in a portfolio, experts say they can be very complex, risky investments and should be used only by experienced investors who have a strong understanding of the instrument.
Some of these alternative investments try to mimic hedge funds. The phrase “hedge fund” has struck up images of greed, corruption and fear in the eyes of many investors since the financial meltdown of 2008. Hedge funds gained prominence in the ‘80s when many of them emerged to follow global macroeconomic strategies related to currency, interest rates and stock index futures markets. By the ‘90s large institutions, including universities and pension funds, started allocating monies to alternative investments.
Before 2008, most alternative investments were only available to accredited investors in private hedge funds but the new breeds of ETFs and mutual funds make them essentially open to anyone. As with any investment, advocates of such funds say extensive research and diversification is critical.
Hedge funds typically come with higher fees because they’re generally more sophisticated and difficult to manage. Morningstar reports that in some cases, the annual expenses can be more than 10 times that of a traditional fund. The potential for greater risk combined with complex strategies and higher fees means, these types of investments are not for all ordinary retail investors.
Investors should do a considerable amount of research before considering funds such as these. They should understand the strategy, have a firm belief of why they think it will work and have a clear view of how that strategy is being implemented.