Alternative Mutual Fund Investing Strategies

What are alternative funds and when should you invest in them?

Real Estate for sale is an example of what alternative funds are invested in
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Alternative funds are mutual funds, or exchange-traded funds (ETFs), that invest in nontraditional securities. These could be things such as real estate, commodities, and leveraged loans. These funds are not always right for most people. But they can be used as diversification tools if used properly.

Alternative mutual funds can be a smart way to gain access to nontraditional investment securities. Before investing in alternative funds be sure to do your research. This can help you figure out if these investment types are right for you.

Key Takeaways

  • Alternative funds are mutual funds or ETFs that invest in nontraditional securities.
  • Price fluctuations for alternative funds can be greater than traditional securities.
  • Because alternative funds do not often have a clear legal structure, the contents of their portfolios may not always be clear.
  • Alternative funds typically have higher market risk, higher expenses, and higher minimum initial investments.

What Are Alternative Funds?

The term “alternative funds” refers to mutual funds, hedge funds, or ETFs that invest in non-conventional investment securities. These may be broadly categorized as securities other than stocks, bonds, and cash.

Alternative funds may invest in real estate, loans, commodities, and unlisted securities, such as art or jewelry.

Alternative Funds Investment Strategies

Alternative funds are most often used for portfolio diversification. That's because performance for alternative investments often has a low correlation to that of the broad market indexes, such as the S&P 500.

Some alternative funds have focused investment strategies. That means they invest in one area, such as commodities. Other alternative funds may invest in a range of alternative investments.

Note

Alternative mutual fund strategies tend to be more complex than conventional strategies.

For instance, alternative funds may invest in securities that are not easily understood; these could be derivatives, currencies, distressed bonds, and more. Alternative funds may also seek to achieve returns above market averages. Or, they may seek to achieve “market neutral” or “absolute returns” by using both long and short strategies.

What Should You Know Before You Invest?

Here are some things to keep in mind before investing in alternative funds.

  • Market risk: Investors should be aware that price fluctuations can be greater than traditional securities, such as stocks and bonds.
  • Expenses: Alternative funds tend to have higher expenses than most mutual funds and ETFs. Management costs can be high for alternative funds; the expense ratio can be above 1.50%. This is because of the research and high levels of trading compared to the average actively managed mutual fund.
  • Minimum investment: Many alternative funds have minimum initial investments, such as $10,000 or higher, or they may require the investor to have a net worth of at least $1 million before investing.
  • Structure: Alternative funds do not typically have a clear legal structure. That means the contents of their portfolios may not always be clear. Do your best to find out the fund’s objective and holdings. You should also understand how they function in capital markets. 
  • Fund manager: Most alternative funds are actively managed. And it's crucial to know who is managing the fund. Be sure that the manager has years of experience and a strong track record.
  • Performance history: Past performance is no guarantee of future results. But it can give you an idea of what to expect from the fund. Look for long-term returns of at least five years; avoid funds with shorter histories.

Tip

Be cautious about investing in alternative funds with broad swings in performance. That means they have extreme highs and lows.

The Bottom Line

Alternative funds are not for everyone. They often have high market risk, high expenses, and high minimum initial investment. If you're looking to diversify, you can also do this by building a portfolio with funds in different categories, capitalization, and assets. You may also diversify in focused areas, such as industrial sectors.

You may also choose mutual funds or ETFs that incorporate alternative securities or strategies into your portfolio. Alternative funds are not necessary for diversification; they're also not needed to achieve returns that exceed broad market averages. But they can work if you use caution. Always be sure to do your research before investing.