Alternative funds are exchange-traded funds (ETFs) or mutual funds that invest in non-traditional securities, like real estate or commodities. Usually, they are not appropriate for most investors but, if used properly, they can be used as a diversification tool.
If you are interested in learning what alternative funds are and when you should invest in them, be sure to keep reading. However, before investing in alternative funds, make sure you fully research them to see if it’s the right move for you.
What Are Alternative Funds?
Alternative funds generally refers to mutual funds, exchange-traded funds (ETFs), or hedge funds which are invested in non-conventional investment securities. For instance, they may invest in real estate, loans, commodities, and unlisted securities, such as jewelry or art.
Alternative Funds Investment Strategies
In most cases, alternative funds are used for portfolio diversification strategies. This is because performance for alternative investments usually have a low correlation to the broad market indices. Some may focus on investment strategies, which means that they invest in one area, such as commodities. On the other hand, other alternative funds may invest in a range of alternative investments. For instance, they may invest in securities that are easily understood, such as derivatives, currencies, or distressed bonds.
Before You Invest in Alternative Funds
Here are some things you should keep in mind before investing:
- Expenses: Alternative funds tend to have higher expenses than those of most mutual funds and ETFs. For instance, management costs can be high. This is because of the extensive research and high levels of trading (turnover) compared to the average actively-managed mutual fund.
- Market Risk: Alternative funds invest in non-traditional securities. For that reason, investors should be cautious of price fluctuations which can be greater than traditional securities, such as stocks and bonds.
- Structure: Since they usually don’t have a clear legal structure, the contents of their portfolios are not always clear to the investor. Try your best to understand the fund’s objective and holdings. Additionally, you should also know what the holdings are and how they function in capital markets.
- Performance History: Past performance is no guarantee of future results but it can give you an idea of what to expect from the fund. It is important to look for long-term returns of at least five years and avoid funds with shorter histories. Also, be cautious about investing in alternative funds with broad swings in performance (extreme highs and lows).
- Fund Manager: Alternative funds are actively-managed, so it’s important to know who is managing the fund. Make sure that the manager has a lot of experience and has a track record of performance associated with the fund you are considering.
- Minimum Investment: Many alternative funds have minimum initial investments, such as $10,000 or higher. They may also require the investor to have a net worth of at least $1 million before investing.
Author’s Verdict
Alternative funds aren’t for everyone, so it is important that you do your research to find out if it’s right for you. They usually have higher expenses, higher market risk, and higher minimum initial investments than the average mutual fund or ETF.
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