What Are Alternative Investments? Definition and Examples

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Alternative investments are financial assets that fall outside the conventional categories of stocks, bonds and cash, along with the mutual funds and exchange-traded funds that hold those assets. The label covers a wide mix: private equity and venture capital, hedge funds, managed futures, real estate, commodities, farmland, art and collectibles, cryptocurrencies, peer-to-peer loans and many derivatives contracts. They have little in common except what they are not. Still, they tend to share a set of traits, including limited liquidity, hard-to-pin-down valuations, higher fees and lighter disclosure, and those traits determine how they behave in a portfolio.

What counts as an alternative investment

The definition works by exclusion. A traditional portfolio is built from three building blocks: equities (ownership in public companies), fixed income (loans to governments and companies in the form of bonds) and cash or cash equivalents. A share of a publicly traded company, a Treasury note or a money market fund all sit inside those categories. So does an ordinary index fund or ETF that holds them.

Anything else, often shortened to “alts,” is a candidate. The boundary is not perfectly sharp, and a few cases cause regular confusion:

• Real estate is often classified as an alternative, even when it is held through a publicly traded real estate investment trust (REIT) whose shares trade like stock. Some allocators treat listed REITs as equities and only private property as an alternative.
• Venture capital and private equity are, at bottom, ownership stakes in companies. What makes them alternative is that the companies are private: there is no exchange, no daily price and no easy exit.
• Peer-to-peer lending and private credit resemble bonds economically, since the investor earns interest on a loan. The difference is that the loans are made privately, often to borrowers who would not issue public debt.
• Commodities are physical goods, but investors frequently hold them through futures contracts or exchange-traded products rather than barrels and bars.

Characteristics that alternative assets share

Limited liquidity

Liquidity is how quickly an asset can be turned into cash without accepting a lower price. Shares in a heavily traded public company can usually be sold within seconds during market hours. A rare bottle of wine may wait weeks or months for the right buyer. Private funds often add formal restrictions on top of thin markets: lock-up periods during which money cannot be withdrawn, limited redemption windows, or a fund life measured in years.

Valuation is difficult

A public stock has a price set continuously by the market. Many alternatives trade rarely or are one of a kind, so their value at any moment is an estimate. The 1933 Saint-Gaudens Double Eagle $20 gold coin is an extreme case: only one can legally be held in private hands, leaving almost no comparable sales to anchor a price. Private funds face a milder version. Their reported values often rely on appraisals or models rather than trades, and the net asset value they report can lag what a buyer would actually pay.

High minimums and fees, lower turnover costs

Many alternative vehicles require large minimum commitments and charge layered fees, such as a management fee on assets and a performance fee on gains. Compared with low-cost mutual funds and ETFs, the total cost is often much higher. One partial offset is turnover: because these assets are bought and held rather than traded frequently, ongoing transaction costs can be lower than for actively traded conventional portfolios.

Less public information

Public companies file regular, audited reports, and registered funds publish standardized performance and fee disclosures. Many alternative investments have fewer obligations and fewer opportunities to publish verifiable performance data or advertise to the public. Historical price series may be short, patchy or self-reported.

Potentially low correlation

Correlation measures how closely two assets move together. Because many alternatives are driven by different forces than public markets (rental demand, crop yields, commodity supply, the progress of a single startup), they may move less in step with stocks and bonds. Part of the low correlation reported for some private assets comes from infrequent, appraisal-based pricing that smooths reported values, so a calm-looking return series does not always mean the underlying asset was calm.

Types of alternative investments

Real estate

Real estate investing ranges from owning physical property directly to holding property-based securities: REITs, real estate mutual funds and real estate crowdfunding platforms. Investors typically look for two sources of return: operating income such as rent, which can provide ongoing cash flow, and capital appreciation of the property itself.

Commodities

Commodities are raw materials such as gold, silver, oil and agricultural products. Gold is a special case: it has industrial uses but is also widely treated as a store of value, which some investors believe makes its price less tied to the business cycle.

Farmland

Farmland combines features of real estate and commodities. The owner holds physical land, which can appreciate, and may also receive cash from farming operations or from leasing the land to an operator, depending on how crop sales and prices turn out.

Art and collectibles

Fine art, memorabilia, rare coins, stamps, high-end watches and wine can serve as investments that double as a hobby. Their value rests on scarcity, condition, provenance and the reputation of the people connected to them, such as an artist or athlete whose standing grows. They produce no income, carry storage and insurance costs, and depend heavily on the honesty of dealers and authenticators.

Cryptocurrencies

Cryptocurrencies and other digital assets fall outside the traditional scope of stocks and bonds, so they are usually grouped with alternatives. Investors may seek capital appreciation, and some networks pay staking rewards for locking up tokens to help validate transactions. Whether crypto acts as a hedge against other risk assets is disputed, and its price swings can be severe.

Private equity and venture capital

Private equity funds buy stakes in established private companies, or take public companies private, aiming to improve and later sell them. Venture capital is a branch of private equity that funds startups and early-stage firms. Both are equity investing in a broad sense, but capital is committed for years, often called in gradually, and returned only when portfolio companies are sold or listed.

Hedge funds and managed futures

Hedge funds are pooled vehicles that can use strategies ordinary funds typically avoid or face restrictions on: short selling, heavy leverage, derivatives and concentrated bets. Managed futures funds trade futures contracts across commodities, currencies, interest rates and stock indexes, often following systematic trend rules. Both are judged largely on their ability to deliver returns not explained by market moves, a quantity known as alpha.

Peer-to-peer lending and private credit

Peer-to-peer lending platforms connect investors with individuals or small businesses seeking loans, often riskier borrowers. Defaults are a central risk, and an individual loan typically cannot be sold easily before it matures. Private credit funds operate on a larger scale, lending directly to companies outside the public bond market.

Derivatives

Options, futures, swaps and similar contracts derive their value from an underlying asset. They are sometimes listed among alternatives in their own right and are often the tools hedge funds and managed futures programs use.

Worked examples: how the traits play out

Hypothetical example 1: fees on a private fund

Suppose an investor puts $1,000,000 into a hedge fund that charges a 2% annual management fee on assets and a 20% performance fee on profits, a structure long known in the industry as “2 and 20.” Assume, for simplicity, that:

• The fund earns a gross return of 12% for the year.
• The management fee is charged on the starting balance.
• The performance fee is charged on profit after the management fee, with no hurdle rate and no prior losses to recover.

The arithmetic:

1. Gross gain: $1,000,000 × 12% = $120,000
2. Management fee: $1,000,000 × 2% = $20,000
3. Profit after management fee: $120,000 − $20,000 = $100,000
4. Performance fee: $100,000 × 20% = $20,000
5. Net gain to the investor: $100,000 − $20,000 = $80,000, or 8%

The fund’s managers keep $40,000 of the $120,000 the strategy produced, one-third of the gross return. Compare a hypothetical index fund with a 0.10% expense ratio earning the same 12% gross: the investor would net about 11.9%. For the hedge fund to match, it would need a gross return of roughly 16.9% under these assumptions. That gap is why fee structure, hurdle rates and high-water marks (provisions that prevent paying performance fees twice on the same gains) matter as much as the strategy itself. Risk-adjusted measures such as the Sharpe ratio should be computed on net, not gross, returns.

Hypothetical example 2: the cost of needing cash quickly

Suppose an investor bought a piece of film memorabilia for $50,000 and a recent appraisal puts its value at $70,000. On paper, that is a 40% gain. Now the investor needs cash within a month.

• With few active buyers, a quick private sale might clear at $58,000.
• If the investor instead consigns the item to an auction, assume a 15% seller’s commission and a sale at the appraised $70,000: proceeds would be $59,500, and the money might not arrive for weeks.

Either way, the realized gain is far below the appraisal-based figure, before any storage, insurance or authentication costs. The appraisal assumed a patient seller; the forced sale shows what illiquidity costs. A stock position of the same size could usually be sold the same day at close to its last quoted price.

Regulation of alternative investments

Alternative investments often sit under a less clear legal structure than conventional securities. Many private fund advisers fall within the scope of the Dodd-Frank Act of 2010, and their practices are subject to examination by the Securities and Exchange Commission (SEC). The offerings themselves, however, frequently are not registered with the SEC, so investors do not receive the standardized disclosure documents, fee tables and ongoing reporting that registered stocks, mutual funds and ETFs provide.

That gap is the main reason access is restricted. Many private alternative offerings in the U.S. are open only to accredited investors, defined by the SEC as individuals who meet at least one of these tests:

• Net worth above $1 million, alone or with a spouse or spousal equivalent, excluding the value of a primary residence.
• Annual income of at least $200,000 in each of the two most recent years ($300,000 combined with a spouse or spousal equivalent), with a reasonable expectation of the same in the current year.
• Holding certain professional licenses in good standing, namely the FINRA Series 7, Series 65 or Series 82.

The logic is that such investors can better evaluate risky offerings and absorb losses. Accreditation is a legal threshold, not a sign that an investment is sound.

Lighter oversight also attracts fraud. Unusual assets, opaque pricing and promises of high returns are common features of scams, whether the pitch involves rare coins, private loans or digital tokens. Due diligence falls on the investor: verifying the manager’s registration and record, knowing who holds and values the assets, and reading the offering documents in full.

How to invest in alternative investments

The route depends on the asset, and many carry custody, storage or maintenance fees that a stock trade does not.

• Private equity and venture capital: through private equity firms, venture funds and, for smaller amounts, equity crowdfunding platforms. Some publicly traded companies and funds also provide indirect exposure.
• Real estate: by buying rental property directly, buying shares of publicly traded REITs, or using real estate crowdfunding platforms.
• Hedge funds: typically through the fund manager or a broker, usually only for accredited investors.
• Commodities: by buying physical metals, trading futures through a commodity broker, or buying commodity ETFs and mutual funds.
• Art and collectibles: through dealers, auction houses and online marketplaces.
• Cryptocurrencies: through crypto exchanges, brokers and other online platforms. Holdings are kept in a digital wallet that stores the private keys controlling the assets, managed either by the platform or by the investor.

Retail investors who cannot or do not want to buy private funds can use alternative funds, sometimes called liquid alternatives. These are mutual funds and ETFs registered with the SEC that pursue alternative strategies such as long-short equity, managed futures or market-neutral approaches, or that hold alternative assets such as commodities. They offer daily liquidity and standardized disclosure, but their liquidity requirements limit how far they can go into truly illiquid assets, so they rarely replicate a private fund’s exposure exactly.

Tax implications of alternative investments

Alternative assets often follow different tax rules from stocks and bonds, and a single investment can produce more than one type of taxable income. A rental property, for example, generates rental income each year and a capital gain or loss when it is sold.

• Collectibles: The IRS defines art, coins, stamps, antiques and similar items as collectibles. Net long-term capital gains on collectibles are taxed at a maximum rate of 28%, higher than the top long-term rate that applies to most stocks.
• Digital assets: Cryptocurrency, stablecoins and non-fungible tokens are treated as property for U.S. tax purposes. Selling them for dollars, using them to buy goods or services, or exchanging one digital asset for another can each trigger a taxable gain or loss. Changes in a digital asset’s value produce capital gains or losses when realized, unlike holding U.S. dollars.
• Real estate deferral: Section 1031 like-kind exchanges allow investors to defer capital gains tax when they sell investment real estate and reinvest the proceeds in similar property within set deadlines. Qualified Opportunity Zone investments offer deferral, and potentially exclusion of later gains, when capital gains are reinvested in designated areas.
• Partnership structures: Many private equity and hedge funds are organized as limited partnerships, which pass income through to investors and report it on Schedule K-1. K-1s can arrive late in tax season and may create filing obligations in multiple states.

Why investors use alternatives

Diversification

Institutions such as pension funds, endowments and family offices commonly allocate part of their portfolios to private equity, real estate, hedge funds and real assets so that not everything tracks stocks and bonds. If an alternative holds its value when stocks fall, the portfolio’s drawdown is smaller. But correlations can rise sharply during market stress, when diversification is needed most.

Inflation protection

Hard assets such as real property, commodities and gold are often used as inflation hedges, since their prices and the income they generate can rise with the general price level. The relationship has been inconsistent over different periods, so it is worth testing against an asset’s history rather than assuming.

Return potential and specialized exposure

Alternatives give access to markets public securities do not reach: young private companies, specific property types, individual loans, physical goods. Higher return potential comes with higher risk, complexity and fees. Some investors also value owning something they care about, such as signed memorabilia.

Limitations and risks

Fees, illiquidity, valuation uncertainty and limited disclosure, described above, are the core risks, and lighter oversight raises the risk of fraud and misconduct. Two more stand out:

• Complexity: Terms such as capital calls, waterfalls, hurdle rates and redemption gates can be hard to understand, which increases the chance of an unsuitable purchase.
• Concentration: A single property, startup or collectible can lose most or all of its value, and minimum investment sizes can make spreading the risk difficult.

These characteristics are why alternatives are generally considered unsuitable for novice investors or for money needed in the near term. They suit investors who can tolerate illiquidity, understand the specific product and its fees, and use alternatives to complement a core portfolio rather than replace it. The test is the net return after fees and taxes and how the asset behaves alongside the rest of the portfolio.

Alternative vs. traditional investments

Two related terms are easy to mix up with the asset category itself. Alternative asset management refers to the business of running these strategies: the firms that sponsor private equity, hedge, real estate and private credit funds and earn fees on the capital they manage. An alternative investment fund is a pooled vehicle that invests in alternative assets or strategies; in the European Union, the term also has a specific legal meaning for funds outside the regulated retail fund framework.

The Bottom Line

Alternatives matter most to investors who can lock up money for years, understand a product's fees and terms, and want holdings that move differently from stocks and bonds. They generally do not suit novices or money needed soon. Judge any alternative by its return after fees and taxes and by how it behaves next to a core portfolio, and verify the manager and the offering documents before committing.