Alternative investments (or “alts,” as they are often called) have been a staple in portfolios held by pension funds, large foundations, endowments, and other institutional investors for decades. In recent years, a growing number of high-net-worth individuals have explored alts. Unfortunately, these investments are sometimes promoted without adequate explanations of the risks they entail.
In this article, we provide a balanced, unbiased overview of common types of alternative investments. We outline the general pros and cons of alts, define each type (with some exceptions noted below), highlight their key advantages and disadvantages, and emphasize the need for thorough due diligence before investing. Let’s get started.
What does the term “alternative investments” cover?
Alternative investments encompass any investment outside of publicly traded equities, bonds, mutual funds, ETFs, and cash-like assets such as CDs and money market funds. Alternative investment funds acquire assets not traded in public markets or combine publicly traded assets in ways that cannot be offered to retail (small) investors due to regulatory restrictions.
Common alternative investments include venture capital, private equity, private credit, private real estate, and hedge funds. Although we will not be discussing them in this blog post, alts can also refer to commodities, cryptocurrencies (read our blog on Bitcoin), and collectibles such as art or fine wines.
Why do alternative investments appeal to some investors?
Alternative investments have become popular among a subset of high income/high net worth investors for several reasons, including:
Potential for higher returns: Some investors believe that alternative investments offer opportunities not available in public markets. However, these investments often involve higher risks, including the potential for loss of capital, higher costs, illiquidity, and market volatility. Many alt funds invest in privately held companies that may be unproven and risky or pursue high-risk strategies that seek substantial returns but offer no guarantee of success.
Access to start-up companies: Start-ups in the U.S. have been staying private for longer. Investors who stick with public equities may miss out on potential pre-IPO growth in value. While a few start-ups have become blockbusters (such as Google, Meta, and Airbnb), investors who supplied them with early capital in the private markets earned significant returns. However, these outcomes are rare, and early-stage investments come with substantial risk.
Diversification: Alts are marketed as assets that do not move in lock-step with public equities or bonds. While this is partly true, the diversification benefits of alts can be overrated.
What are some key drawbacks of alternative investments?
Before investing in alts, it is important to understand the risks that differ from publicly traded investments:
Illiquidity. Unlike stocks, bonds, or mutual funds, which can be easily sold, alternative investments often tie up investors' money for longer periods of time, some even 7-10 years. While some platforms facilitate secondary sales, liquidity is still highly limited.
High fees and complex fee structures. Alts generally have higher fees than publicly traded funds, often including an annual management fee and a performance-based fee.
Limited transparency and disclosures. Alt funds do not have the same reporting requirements as public companies, ETFs, and mutual funds. Disclosures vary by fund manager and investment structure.
Difficulty valuing the fund’s assets. Since private assets lack market prices, reported returns may appear less volatile than public markets, but this does not necessarily reflect actual investment risk or potential losses. Investors should carefully review fund valuation methodologies.
High minimum investment requirements. Many alternative investments require at least $100K to $250K, limiting diversification opportunities for individual investors.
Tax complexity. Alternative investment funds are often structured as limited partnerships (LPs), which issue K-1 tax forms that can add costs and complicate tax filing.
Capital calls. When you buy shares of a mutual fund or ETF, your money is used to buy stocks or bonds immediately. When LPs commit capital to alt funds, it may not be put to work (“called”) right away. Committed capital that is waiting to be invested (called “dry powder”) can drag down returns as it sits in cash-like investments.
What are some of the most popular types of alternative investments?
Venture Capital (VC)
VC funds invest in start-ups, many of which are not yet profitable. These funds expect some failures, counting on a few successes to offset losses. VC funds typically follow the “2-and-20” fee model (2% annual management fee and 20% performance fee on profits).
Private Equity (PE) PE funds invest in mature, privately held businesses to help them grow or acquire public companies to take them private. PE generates returns by improving the businesses they buy before selling them at a profit (to another company or through an IPO). These funds also often follow the 2-and-20 fee model and have a typical investment timeline of 7-10 years.
Private Credit Private credit funds lend money to companies as an alternative to bank loans or the public bond market (which is primarily accessed by larger companies with established credit ratings). Their investors earn a return based on what the borrowers pay on their loans. Unlike bonds, which typically pay a fixed rate of interest, private loan rates are often tied to benchmarks such as the Secured Overnight Financing Rate (SOFR) or, historically, LIBOR, rather than the federal funds rate, and move up or down over time.
Private credit, which has been expanding quickly, gives investors exposure to a diversified pool of loans that typically offer higher yields than investment-grade bonds, and a different set of borrowers than those in the high-yield bond market, often including mid-sized or private companies that may not have access to traditional financing options.
There are various types of private credit – the most common are direct lending, distressed lending, mezzanine financing, and specialty finance. Each involves a different level of default risk.
Private credit fund fees are generally lower than those for venture capital and private equity funds – instead of “2-and-20,” private credit funds often charge a 1.5% annual fee and 15% of returns above a specified hurdle rate. Still, those fees are much higher than what bond mutual funds charge.
As with most alts, liquidity for private credit investments is limited, and investors are often required to hold positions for several years. The industry is trying to address this with new but still-developing structures and platforms.
Private Real Estate
Commercial real estate is the third-largest asset class in the U.S. after stocks and bonds. Yet, aside from owning a home, most investors typically have little exposure to real estate. Real Estate Investment Trusts (REITs), which are publicly traded or private entities that invest in a diversified portfolio of commercial real estate properties, offer one way for investors to gain exposure to the sector while generating current income.
Another option is a private real estate fund, which typically invests in multiple properties or, in some cases, a single property. Some funds acquire existing properties and improve them to increase their value, while others develop new properties from the ground up.
Private real estate funds may offer tax advantages over REITs, depending on their structure and an investor’s tax situation. However, like venture capital and private equity, private real estate investments are typically illiquid, with investors often required to commit capital for several years.
Hedge Funds
Hedge funds invest in publicly traded instruments using complex strategies, including derivatives, leverage, and short selling. They aim to deliver returns that are less correlated with the overall equity or bond market, thus potentially offering a “hedge” (hence the name) against declines in those markets. However, correlations can fluctuate based on market conditions. Strategies include:
Long/short equity – taking long and short positions in stocks
Global macro – Investing in diverse global markets based on macroeconomic trends and perceived opportunities.
Event-driven – Trading around corporate events such as announced but not yet completed mergers, acquisitions, spin-offs, or restructurings due to financial distress.
Relative value – Buying stocks or other instruments while simultaneously shorting related ones that appear mispriced on a relative basis, with the expectation that their price relationship will normalize.
Multi-strategy – Combining multiple hedge fund strategies within a single fund to diversify risk and enhance return potential.
Hedge fund fees often follow the “2-and-20” model (a 2% annual management fee and a 20% performance fee on profits), but fee structures vary across funds. Many expenses can be passed through to limited partners (LPs), which can further reduce net returns. Hedge fund shares are not publicly traded, and redemptions are typically restricted—though hedge funds may allow LPs to redeem a portion of their investment at specified intervals (e.g., quarterly or annually) with prior notice.
Many hedge funds impose an initial lock-up period (often 1–3 years), during which LPs cannot redeem any of their shares. In times of market stress, redemptions may be restricted, delayed, or suspended. Performance is highly dependent on the strategy and the fund manager’s skill. Because hedge funds are not required to publicly disclose their full holdings, investors may face challenges in evaluating risk exposure and strategy effectiveness.
How can I evaluate whether an alt investment is worth consideration?
Investing in alts requires due diligence beyond what is necessary for public market investments. Consider:
Manager track record – A strong track record may indicate expertise, but past performance does not guarantee future results.
Performance verification – Performance across managers varies widely within a given type of alts, yet high investment minimums prevent most individual investors from buying into a range of private funds to diversify the risk that a given fund will do poorly. It’s important to clarify how a given fund determines its performance when the value of its investments is hard to determine.
Fees and expenses – Investors need to understand the various types of fees a fund charges, how they are calculated, and which expenses of the fund they will have to cover.
Operations/back-office integrity – Work with a financial professional to review fund documents and ask critical questions before investing.
Summary of Key Considerations When Investing in Alternatives
Alternative investments may offer attractive return opportunities from sources not typically accessible through traditional investments. However, they also entail risks that differ from those in public markets, including high fees that can reduce net returns, illiquidity, a lack of transparency, and challenges in measuring performance.
Alts may play a role in an overall portfolio strategy for qualified investors, but thorough due diligence and professional guidance are strongly recommended in this space.
At Gold Medal Waters, we believe that serving our clients means going beyond traditional advice. We are a fee-only financial advisor dedicated to helping you to reach your financial goals based on how your life actually works and what you value most. Book a free, initial consultation to learn more!
Disclosure: Advisory Services are offered through Gold Medal Waters, a Registered Investment Advisor. This post and material presented are for informational and illustrative purposes only, and do not constitute investment advice and is not intended as an endorsement of any specific investment. As such, this material is not client-specific, we make adjustments in individual portfolios based on each client's financial plan, income needs, risk tolerance and total asset allocation. Interactive checklists are made available to you as self-help tools for your independent use and are not intended to provide investment advice. While Gold Medal Waters believes information derived from third-party sources to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability in regard to your individual circumstances. Investors should carefully consider the investment objectives, risks, charges, and expenses associated with any investment. The information discussed is not intended to render tax or legal advice. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Investing involves risk including the potential loss of principal, and unless otherwise stated, are not guaranteed. Past performance does not guarantee future results. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Consult your financial professional before making any investment decision.
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