Our simple guide to alternative investments

Alternative investments are assets that don't fall into the traditional stock and bond categories.

These assets are not listed on the FTSE All-Share or other major public indices, meaning they are not publicly traded and tend to be less liquid than traditional investments. Liquidity refers to how quickly and easily an asset can be converted into cash without significantly affecting its price. Because many alternative investments involve privately held or physical assets, selling them can take longer compared to shares or bonds.

They are often considered 'non-traditional' assets because they behave differently from the stock market we typically hear about on the news.

Remember, the value of all investments can go down as well as up and you may get back less than has been paid in.

There are many different types of investments that can be described as alternative investments. Here are some examples:

• Infrastructure: Investments in essential systems like roads, bridges, energy networks, and utilities that support economic activity.
• Private equity:  Ownership stakes in private companies that are not listed on public stock exchanges.
• Commodities: Physical goods such as gold, oil, or agricultural products that are traded for their value at the time.
• Hedge funds: Pooled investment funds that use a range of strategies to try and make returns, often with higher risk and complexity.
• Venture capital – Funding provided to early-stage businesses with potential for growth
• Collectibles – Tangible items like art, antiques, or rare coins that can change in value over time.

Traditional stocks, such as shares or equity funds, generally move in line with the broader stock market. While you can reduce some risk by spreading investments across different regions, sectors or companies, stocks as a whole often rise and fall together. This means a portfolio made up entirely of shares can still be heavily affected by major market swings.

By introducing assets like property, commodities, or private equity, you spread your risk across different areas that don’t always follow the same patterns. This diversification helps reduce reliance on one asset class. So, if the stock market is underperforming, these alternative investments may hold steady or even grow, helping to smooth out volatility and create a more balanced portfolio.

Some alternative investments are naturally longer-term. For example, infrastructure projects or private company growth can take many years to deliver returns. Commodities, while sometimes traded actively, can also be part of a longer-term strategy. These timeframes mean alternatives often require patience but can offer stability and potential growth over time.

One potential advantage of alternative investments is the opportunity for higher returns. Certain assets, such as hedge funds or venture capital, are specifically designed to maximise performance. While these options often carry higher risk, they can also deliver stronger results compared to traditional investments.

Alternative investments can also help protect against inflation. Assets like property and commodities often maintain or increase their value when everyday prices rise, which can help preserve your purchasing power over time. Combining alternatives with traditional stocks and bonds creates a more balanced and resilient portfolio. This mix spreads risk across different asset types, making you better prepared for changing market conditions and reducing the impact of volatility.

One reason some investors consider alternative investments is that they behave differently from traditional assets like equities and bonds. Shares and equity funds often move in line with the broader stock market – when markets rise, their value usually increases, and when markets fall, they often decline too. Bonds, on the other hand, tend to be influenced by interest rates and economic conditions. This close link to market movements means traditional portfolios can be heavily impacted by volatility.

Alternative investments, such as commercial property, commodities, private equity, or infrastructure, are influenced by different factors.

For example, commercial property values depend on rental income and demand for office or retail space, rather than daily market swings. Commodities like gold or oil may rise during periods of inflation or global uncertainty. Infrastructure projects – such as roads or energy facilities – often provide steady returns backed by government spending, making them less sensitive to short-term market volatility. Some alternatives, like infrastructure or private equity, are naturally longer-term because projects or company growth can take many years to deliver returns.

Because these assets follow different patterns, adding them to a portfolio can improve diversification. Diversification means spreading investments across different types of assets so they don’t all react the same way to market changes. While alternatives can carry higher risk and may be less liquid than traditional investments, they can help smooth out overall performance. When one part of your portfolio is under pressure, alternatives may hold their value or even grow, creating a more balanced approach to long-term goals.

Athough alternative assets can be a way to balance and diversify your investment portfolio, there are risks and drawbacks you need to consider.

1. Liquidity:
   One of the biggest drawbacks of alternative investments is liquidity – the ease and speed with which you can turn an asset into cash. For most DIY investors, traditional shares and bonds are relatively easy to trade on public markets, often within minutes. On the other hand, alternatives like commercial property, infrastructure projects, or private equity can take months or even years to sell.
   
   For example, selling a commercial building involves finding a buyer, negotiating terms, and completing legal processes, which makes it far less liquid than selling a stock. This lack of liquidity can be a problem if you need quick access to your money.
2. Stale valuations:
   There’s also a risk of stale valuations. This happens when the reported value of an asset doesn’t reflect its current market value because it hasn't been updated regularly. Private equity and private debt are particularly affected by this, as valuations may only be made a few times a year or even just once a year. 
3. Costs, risk and transparency:
   Other drawbacks include higher costs, greater risk, and less transparency compared to traditional investments. Costs can include management fees, performance fees, and transaction charges, which can often be higher than those for shares or bonds. Risk can come from market factors, leverage, or just by how complicated the investment strategy is. As well as this, transparency is often limited because many alternative investments operate in private markets, making it harder to access detailed information about performance or underlying assets.
4. Taxes:
   Taxation is another important consideration. Many alternative investments can have complex tax implications, such as capital gains tax when you sell an asset, or income tax on distributions. Some structures, like private equity or hedge funds, may involve offshore jurisdictions or tax reporting requirements that add complexity. It’s essential to understand how tax rules apply to your chosen investments and seek professional advice if needed.