There are probably as many fads in the investing world as there are in clothing styles for teenage girls. Currently alternative investments are all the rage. Mutual fund companies can't develop new alternative products to peddle fast enough. Fads are fun in fashion and pop-culture they aren't always a good thing in the investment world.
What are alternative investments?
Alternatives are basically investment vehicles that aren't purely stocks, bonds, or cash. The purpose of alternatives is generally to diversify an investment portfolio. They come in many shapes and sizes including:
- Hedge funds
- Macro strategy funds
- Commodities and managed futures
- Real estate
- Precious metals
- Long/short equity
- Convertible arbitrage
- Private equity
- Vulture funds
- Venture funds
- Merger arbitrage
Besides true hedge funds, many of these strategies are available in mutual fund and exchange-traded fund wrappers. The latter two are significant in that they can be purchased by all investors, not just accredited investors. This makes packaging these strategies especially attractive to mutual fund companies for distribution.
Don't get me wrong, I like the idea of alternative investments and have used a select few alternative mutual funds and ETFs in client portfolios for over a decade.
But like anything else once mutual fund companies get wind of what seems like a good new idea (i.e. something that investors will like or that they can push via the financial advisor channel) it's much like throwing raw meat into a shark tank. With the new rules allowing hedge fund promoters to advertise these pitches will be added to the noise that investors have to sift through.
Some questions to consider.
Before buying an alternative fund or product here are a few questions to consider:
- Do you understand the investment strategy?
- What benefit will this investment provide to your overall portfolio?
- What are the expenses? Are they worth incurring for the expected benefit of investing?
- Are there any restrictions on redeeming your investment? Typically (but not always) with a mutual fund or ETF the answer is no, hedge funds may have a lockup period or other restrictions.
- Have this fund's performance been tested in real market conditions or just back-tested on a computer?
Remember, large endowments like that of Yale University may use alternative investments extensively (and very successfully), but they have access to the expertise to perform proper due diligence. Do you? Does the financial advisor recommending these funds really understand them? Make sure that you do before investing.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.