What are Alternative Investments? Traditional investments include long positions in equity, fixed income, and cash commodity markets, all within developed economies. Some non-traditional or Alternative Investments, like Real Estate and Natural Resources, fall outside the realm of these traditional investments because they involve separate, niche markets. Alternative Investments do exist within the context of equity and fixed income markets, however, and include Private Equity, Hedge Funds, Managed Futures, and Securitized Products. These investments use strategies and techniques not available to traditional investment vehicles like mutual funds in order to produce and enhance their returns. These unique tools can include futures, short-selling, leverage, options, overlays, arbitrage, and private markets. What are Market Neutral/Absolute Return strategies? Alternative Investments target returns on an absolute basis. This means that alternative strategies target a specific range of performance, and attempt to produce targeted returns regardless of the underlying trends of the stock or bond markets. This stands in contrast to traditional investments like mutual funds, where success or failure is often measured in terms of performance in relation to a stock index, most often the S&P 500. Most Alternative Investments attempt to maintain a low correlation to the stock market. What is a Hedge Fund? Hedge Funds are set up as limited partnerships, Hedge Funds invest in global capital markets with greater flexibility than traditional instruments. Hedge funds often have quarterly or monthly liquidity, with occasional lock-up incentives. Single managers most often employ one specific strategy, which investors can seek out. What are Managed Futures? Managed Futures or Commodity Trading Advisors (CTAs) are funds or managed accounts which actively trade commodity futures, financial futures, or foreign exchange. Liquidity is often quarterly or monthly. Investors can seek out a specific strategy. Aren't Alternative Investments risky? Some Alternative Investments are risky. Like investing in the stock market, investors in alternative strategies can lose capital. Many people equate the term "Hedge Fund" with the much-publicized blow-up of Long Term Capital Management in 1998. Alternative Investments, however, employ varying strategies. While some of these sacrifice stability for high returns, other strategies have been historically more stable than the bond market. Alternative Investments, however, are not intended as stand-alone investments. Rather, they are promoted for their diversification benefits. Modern Portfolio Theory accepts that a portfolio which blends traditional and non-correlated Alternative Investments can enhance returns and actually mitigate risk. Aren't Alternative Investments expensive? As actively managed investments, most Alternatives command higher fees than passive index funds or buy-and-hold strategies. They can also require higher brokerage costs and increase tax liability. As the Alternative Investment industry has grown, however, management fees have become more competitive. Management fees can vary widely and can be negotiable. Performance is nearly always reported after the deduction of fees. How do you measure the performance of Alternative Investments? The standards for measuring performance of traditional investments are straightforward and user friendly. For example, every mutual fund in the country compares its performance to the S&P 500. Major stock and bond indices provide a recognizable benchmark for traditional investments. For Alternative Investments, however, benchmarks are not so clear cut. As market neutral strategies, Alternative Investments target specific risk and return profiles regardless of market conditions. While the performance of many alternative strategies compares favorably with traditional benchmarks, true assessment of these unique investment vehicles can only be made by way of peer group comparisons. As the Alternative Investment industry has matured, it has begun to address the need for performance benchmarks and similar measurement tools. A variety of independent organizations produce indices which allow investors to compare Alternative Investment managers with their peers. These include Hedge Fund Research, Inc. (HFRI), The Barclay Group, and Tass Management. Their indices include broad-based asset class indices like the Barclay CTA Index, strategy specific indices like The Parker FX Index, or market sector indices like the HFRI Energy Index. These benchmarks are improving and developing all the time, to account for such factors as weighting, leverage, and selection and survivor bias. What is Modern Portfolio Theory? The classical foundation for Modern Portfolio Theory, developed by Harry Markowitz in the 1950s, provides a structure in which one can determine, according to a specific set of parameters, an optimal allocation of funds among competing investments in order to arrive at a desired level of reward versus risk. Markowitz' work formalized what investment managers have recognized for thousands of years: divide your holdings into portions, lest one investment fails. Diversification, or the selection of optimal combinations of assets in an investment portfolio is essential to produce the least possible risk for a given level of return. The key is incorporating assets that are "noncorrelated," or whose values ten not to move simultaneously in the same direction.