Wall Street Loves Alternative Investments. Should You?

Some exotic investments fail to live up to the hype.


Broadly, the "alternatives" that have been opened to smaller investors, however, have been disappointing this year. "They did not balance things the way that people expected: In the long run you expect returns that lower your risk—but this year they have just added to it," said Jeff Tjornehoj, head of Lipper Americas Research.

Alternatives as diversification

Alternatives have been hyped as a big change in direction for investors. Instead, they should be considered a part of a diversified investment plan, not the 'whole new world' that some are promising.

Alternatives in general can be a good idea, said Lipper analyst Tom Roseen. But usually in small, prescribed doses for a healthy portfolio mix. "They are like buying insurance," he said. "Not to be used in normal times, but just in case core investments in stocks and bonds get into trouble."

The truth is that stocks and bonds, over time, are most people's core investments. Stocks gain value as corporate earnings rise in an expanding economy, and can also pay dividends. Bonds pay income at a guaranteed rate. Those who stayed invested in stocks after the crash regained most of their loss. Bonds have performed remarkably through this year with double-digit annual returns.

[See Financial Stocks: Do You Dare?]

The fear now is that with interest rates going as low as they have, the bond market is poised for a spectacular fall. A rise in rates would, indeed, cut the principal of bonds by trillions of dollars. That could well come from portfolios of people who thought they were choosing the safe route.

"Unfortunately, many investors learned the wrong lesson from that experience and retreated into so-called 'safe' asset classes such as cash and lower-risk bonds," said BlackRock's Frank Porcelli during in a recent Q&A from the investment firm.

Now it's time to look more broadly at the growing availability of investments that can provide "enhanced performance and yield, but also risk management," he said.