Alternative Investments: Diversification or Distraction?
ALTERNATIVESFEATURED
“Not all diversification is good diversification.” — Howard Marks
Alternative Investments: Diversification or Distraction?
Alternative investments are often described as the part of a portfolio that “smart money” uses to reduce risk and improve outcomes. They’re also marketed as the place where unique opportunities exist—assets you can’t buy in public markets, strategies that behave differently, and returns that aren’t tied to stocks and bonds.
Both stories contain pieces of truth. Both can also mislead.
The problem is that “alternatives” isn’t a single asset class. It’s a catch-all label for everything that doesn’t fit neatly into public stocks, public bonds, and cash. Some alternatives are simple. Many are not. Some can improve a portfolio’s resilience in specific conditions. Others mainly add fees, complexity, and behavioral mistakes—without delivering the diversification investors expect.
This pillar guide is designed to do one thing: give you a decision framework. Not a list of hot products. Not a prediction about which alternative will do well next. A set of principles you can use to decide:
What alternatives actually are
What they can realistically do for a portfolio
Where they usually disappoint
How to evaluate them without fooling yourself
When “no alternatives” is the most disciplined choice
If you’re overwhelmed by noise, this is the high-level map.
What Counts as “Alternative Investments” (and Why the Definition Matters)
“Alternative” is not a risk profile. It’s a category label.
In practice, an alternative investment is anything outside the traditional trio of public equities, public bonds, and cash equivalents. That definition is convenient, but it hides important differences. A gold ETF, a private credit fund, and a vintage watch collection can all be “alternatives,” yet they behave nothing alike.
A useful way to think about alternatives is to group them by return drivers and implementation structure.
A practical taxonomy of alternatives
Real assets
Gold and precious metals
Broad commodities
Farmland and timber (often private)
Infrastructure (public or private)
Private markets
Private equity and venture capital
Private credit (direct lending, specialty finance)
Private real estate
Hedge-fund-like strategies
Long/short equity, market neutral
Global macro
Managed futures / trend-following
Multi-strategy funds
Collectibles and passion assets
Art, watches, wine, cars
Trading cards, memorabilia
Crypto and digital assets
Bitcoin, Ethereum, and other tokens
Crypto funds and yield products (often layered risk)
Structured products and notes
Market-linked notes with embedded options
Principal-protected structures (in theory)
Yield notes that trade upside for coupons
These categories overlap. Some vehicles package multiple exposures. Some “alternative” funds are essentially repackaged versions of familiar factor tilts.
The key point: the label “alternative” tells you almost nothing about risk. You need to identify what you actually own and why it should earn a return.
What Actually Qualifies as an Alternative Investment
How Real Assets, Private Markets, and Hedge Strategies Differ Structurally
The Core Promise: Diversification, Inflation Protection, and “Uncorrelated Returns”
Alternatives are usually purchased for one of three reasons:
Diversification (reduce reliance on stocks and bonds)
Inflation protection (maintain purchasing power when prices rise)
Return enhancement (add a new source of return)
Each of these can be valid. Each is also easy to misunderstand.
Diversification is not a slogan
Diversification is often explained with a single idea: “assets that don’t move together.” That’s correlation. Correlation can help—but it’s not stable, and it’s not the same as diversification in a real-world portfolio.
A more reliable lens is to ask:
Does the asset have different economic drivers than the rest of the portfolio?
Does it produce returns from cash flows that aren’t just stock/bond beta in disguise?
Does it behave differently when it matters, such as in equity drawdowns or inflation shocks?
A simple example: a portfolio that adds an “alternative” fund that mostly owns equities plus leverage is not meaningfully diversified. It’s repackaged equity risk with more moving parts.
“Uncorrelated” is often conditional
Many strategies appear uncorrelated during calm markets. In stress, correlations often rise.
That doesn’t mean diversification is impossible. It means the claim must be tested in the conditions you care about. An asset that diversifies in mild pullbacks but fails during large drawdowns may not solve the problem you’re trying to solve.
Inflation protection is nuanced
Inflation is not one thing. It can be demand-driven, supply-driven, localized, global, short-lived, or persistent. Different assets respond differently.
Some real assets respond to unexpected inflation better than expected inflation.
Some assets hedge specific price components (energy, materials) but not broader purchasing power.
Many “inflation hedges” work poorly over short horizons, then look better when measured over longer horizons.
You don’t need perfect inflation hedging. You need a portfolio that can function across regimes without requiring constant repositioning.
Return enhancement is the most dangerous promise
The idea that alternatives will “boost returns” is where investor expectations often break. Many alternatives are expensive, capacity constrained, or dependent on manager skill. In public markets, costs are low and benchmarks are clear. In alternatives, fees are higher and performance is harder to evaluate.
If your primary motivation is “higher returns,” your standards for evidence should go up—not down.
[Internal link: Correlation Is Not a Constant]
[Internal link: What ‘Inflation Hedge’ Actually Means]
[Internal link: Crisis Correlations Explained]
The Hidden Costs: Fees, Friction, Taxes, and Complexity Drag
Alternatives can fail quietly. Not because the thesis is wrong, but because the frictions are bigger than expected.
Fee layers are common, not exceptional
In public index investing, the cost structure is simple. In alternatives, costs can stack:
Management fees (sometimes high)
Performance fees (incentives, but also asymmetry)
Platform and distribution fees
Fund-of-funds fees (paying fees on fees)
Trading and financing costs inside the strategy
Even when gross performance is decent, net results can disappoint.
Friction you can’t see on a quote screen
Some strategies are mechanically expensive to maintain:
Futures-based commodity exposure can be impacted by roll costs
Real asset exposure can come with storage, insurance, or financing costs (directly or indirectly)
Niche products can have wider spreads and less efficient markets
A strategy can “work” conceptually while losing to implementation frictions.
Tax complexity matters more when returns are modest
Taxes are jurisdiction-dependent and vehicle-dependent, so it’s hard to generalize. The point isn’t that alternatives are always tax-inefficient. The point is that the range of outcomes is wider, and tax treatment may not match what investors assume.
If an alternative is expected to provide a small diversification benefit, taxes and distributions can easily wipe out that edge.
Complexity drag is real
Complexity drag isn’t an expense ratio. It’s what happens when investors don’t fully understand:
what the product owns
why it earns a return
when it should underperform
what the downside looks like
This confusion increases the probability of buying at the wrong time, selling after disappointment, or abandoning the strategy in exactly the period it was meant to help.
A useful rule: if you can’t explain the return driver in one sentence, you probably don’t own it yet—you’re renting a story.
[Internal link: Why Fees Matter More in Alternatives]
[Internal link: Complexity Drag: How Investors Lose Without Noticing]
Liquidity and Valuation: The Two Risks Most Investors Underestimate
If alternatives had one common thread, it’s this: they often change the rules around liquidity and pricing.
Liquidity is a risk factor, not a feature
Illiquidity can be compensated. It can also be exploited. But it must be matched to your time horizon and your ability to stick with the plan.
Illiquidity becomes dangerous when investors treat a long-term commitment like a short-term position.
Common illiquidity features include:
lockups (you can’t redeem for a period)
redemption windows (quarterly or semiannual)
notice periods (you must request withdrawal in advance)
gates (limits on how much can exit at once)
side pockets (assets segregated when hard to value)
Each of these may be acceptable. None of them are minor details.
“Low volatility” can be a valuation artifact
Private assets often report smoother returns than public assets. That can feel comforting, but it can also be misleading.
Why?
Because private markets often use appraisals, models, or infrequent transactions to set values. Public markets reprice constantly. Private values may lag reality, especially during fast shifts in rates or risk appetite.
This doesn’t mean private assets are bad. It means reported volatility may understate true economic volatility. It also means diversification benefits can look better on paper than they behave in the real world.
Liquidity mismatch is the structural risk to watch
Some funds hold less liquid assets but offer relatively frequent redemption terms. This can work in normal times. It can break in stress.
When many investors try to exit at once, the fund may have to sell what it can sell—not what it should sell. That can leave remaining investors with a worse mix of assets. It can also force gates, delayed redemptions, or unfavorable pricing.
Liquidity mismatch is not theoretical. It’s a predictable failure mode.
[Internal link: Illiquidity Premium: Real or Marketing?]
[Internal link: NAV Smoothing Explained]
[Internal link: Gates and Lockups: How Redemptions Actually Work]
A Practical Due-Diligence Checklist (for Regular Investors)
Most individual investors do not need institutional-level due diligence. But you do need a disciplined filter that prevents obvious mistakes.
Here is a high-level checklist that applies across most alternatives.
1) What is the exposure, in plain language?
Can you state what you own without marketing terms?
“A basket of commodity futures contracts.”
“Loans to middle-market companies with limited liquidity.”
“A trend-following strategy using futures across multiple asset classes.”
“A private equity fund investing in buyouts over a multi-year period.”
If the description requires paragraphs, you probably don’t have clarity yet.
2) What is the return driver?
Every investment return comes from something:
cash flows (interest, rent, business earnings)
price appreciation (scarcity, demand)
risk premia (bearing a risk others avoid)
skill (manager selection and execution)
structural features (option selling, leverage, carry)
If the return driver is vague—“access,” “innovation,” “exclusive opportunities”—that’s not a driver. That’s positioning.
3) What are the risks in drawdowns?
Don’t ask “what can I make?” Ask “what can happen?”
How did it behave in equity selloffs?
How does it behave when rates rise quickly?
What happens when liquidity disappears?
Is leverage involved, directly or indirectly?
What would make this strategy fail for years?
4) What are the total costs?
Look beyond the headline fee:
management fees
performance fees
trading costs
financing costs
platform fees
embedded costs in the structure
If costs are hard to estimate, that itself is information.
5) What is the liquidity contract?
Not “can I sell,” but “under what conditions, at what price, with what delays?”
lockups, redemption windows, notice periods
gates, side pockets
valuation method during stress
6) What is the benchmark?
If an alternative has no benchmark, it can’t be evaluated honestly.
The benchmark doesn’t need to be perfect. It needs to answer: what is the opportunity cost?
If you’re taking equity-like risk, compare to equities.
If you’re taking credit risk, compare to credit.
If the goal is crisis resilience, compare behavior in drawdowns.
7) Do you have a holding period and a rebalancing rule?
Most alternative allocations fail because investors react emotionally to periods of underperformance.
Write down:
why you own it
what conditions would make you reassess
how long you’re willing to hold it
how you will rebalance (if at all)
If you can’t commit to the holding period, you shouldn’t commit the capital.
[Internal link: Alternative Investment Due Diligence Checklist]
[Internal link: How to Benchmark Alternatives Without Fooling Yourself]
[Internal link: Operational Risk 101: Custody, Counterparties, Leverage]
Major Alternative Categories: A High-Level Playbook
This section introduces the major alternative buckets and the tradeoffs that matter. It’s intentionally high-level. Cluster articles will go deeper.
Gold: hedge narrative vs long-run uncertainty
Gold is often treated as an all-weather hedge. Historically it has sometimes helped in inflationary or crisis environments, and sometimes disappointed for long stretches.
Key tradeoffs:
No cash flow; return depends on price
Can hedge certain tail risks, but timing is uncertain
Implementation matters (physical, allocated, ETF structure)
Gold can be a diversifier. It can also be dead weight for long periods. The decision depends on what problem you’re trying to solve and how much tracking error you can tolerate.
When Gold Has—and Hasn’t—Worked as a Hedge
Commodities: inflation sensitivity with implementation nuance
Broad commodities are often positioned as inflation protection. The reality depends heavily on how exposure is obtained—often through futures.
Key tradeoffs:
Futures-based exposure introduces roll yield and curve dynamics
Performance can be cyclical and volatile
Works best as a regime hedge, not a steady compounder
[Internal link: Commodity ETFs and Roll Yield Explained]
Real estate as an “alt” sleeve: public vs private differs
Real estate exposure can be public (REITs) or private (direct holdings or funds).
Key tradeoffs:
Public REITs trade like equities in many environments
Private real estate has appraisal smoothing and liquidity limits
Both can be sensitive to rates and leverage
Real estate may diversify, but it is not automatically defensive.
REITs vs Private Real Estate: What’s the Difference?
Private equity and venture: access, selection, and vintage risk
Private equity and venture are often framed as superior return engines. They can produce strong outcomes, but dispersion is large and access matters.
Key tradeoffs:
Illiquidity and capital call structures
Manager selection and platform access are critical
Vintage risk: entry timing can matter more than investors admit
Fees are typically high
For most retail investors, the biggest risk is paying institutional fees for non-institutional access.
Private Equity for Retail Investors: Access vs Reality
Private credit: yield appeal with credit cycle exposure
Private credit has grown rapidly because investors want income and because banks retreated from certain lending.
Key tradeoffs:
Credit risk doesn’t disappear because loans are private
Underwriting quality is hard to observe
Liquidity mismatch can be severe depending on the vehicle
Reported stability can mask cycle exposure
Private credit can play a role, but it should be evaluated as credit risk plus liquidity risk—not as “safe yield.”
[Internal link: Private Credit: Yield With a Cycle]
Managed futures / trend: crisis potential with long droughts
Trend-following and managed futures are often used for crisis diversification. They can perform well in certain environments, especially sustained trends across asset classes.
Key tradeoffs:
Can underperform for long periods
Implementation and fees matter
Investors must tolerate “looking wrong” for a while
Managed futures may diversify, but only if you can hold through extended disappointment.
[Internal link: Managed Futures Explained Without the Jargon]
Hedge-fund-like strategies: often factors in disguise
Many hedge fund strategies can be decomposed into familiar exposures: value, quality, momentum, carry, volatility selling, leverage, and various credit/term premia.
Key tradeoffs:
Fees may exceed the value of the exposure
Complexity can obscure simple risk-taking
Capacity constraints can be real in niche strategies
Not all hedge fund strategies are bad. But many are not mysterious. The discipline is separating true diversification from expensive repackaging.
[Internal link: Hedge Fund Strategies vs Factor Investing]
Crypto: high volatility with uncertain long-run risk premium
Crypto is often framed as a hedge, a new monetary asset, or a venture-style bet.
Key tradeoffs:
High volatility and uncertain long-term expected return
Custody and counterparty risks depending on structure
Regulatory and platform risks can dominate market risk
Crypto may have a role for some investors, but it should be sized as a speculative allocation unless you have a robust framework that treats risks honestly.
How to Evaluate Crypto Without Hype
Collectibles: idiosyncratic markets with high friction
Collectibles can deliver strong outcomes for experts with access and domain knowledge. For most investors, the friction is decisive.
Key tradeoffs:
Illiquidity and opaque pricing
Authentication and fraud risk
Storage, insurance, transaction costs
Extreme dispersion (winners and many mediocre outcomes)
Collectibles are best understood as a hybrid of hobby and speculation unless you operate at a professional level.
[Internal link: Collectibles as Investments: The Cost of Being Early]
Access Vehicles: ETFs, Funds, Interval Funds, Notes, and “Tokenized” Versions
For alternatives, the vehicle often matters more than the concept. Two products can claim exposure to the same thing and deliver very different outcomes.
Public wrappers: ETFs and ETNs
ETFs generally hold underlying assets or use derivatives within a regulated structure. The details matter, but the framing is familiar.
ETNs are unsecured debt obligations of an issuer designed to track an index. That introduces issuer credit risk. Investors sometimes overlook this because the product “looks like an ETF” in a brokerage account.
The correct question is: what do I own, and what happens if the issuer fails?
ETF vs ETN: What You Actually Own
Private funds: limited liquidity and limited transparency
Private funds often provide access, but they change the liquidity contract and the information available.
You need to know:
redemption terms
valuation methodology
fee structure and incentives
leverage policy
custody and operational controls
This isn’t paranoia. It’s recognizing that private markets are governed by contracts, not continuous public pricing.
Interval and tender-offer funds: liquidity with conditions
These structures are often marketed as a bridge between private markets and retail access.
They can be useful. They can also confuse investors by implying liquidity that is conditional.
Key features to understand:
redemption occurs at specific intervals
the fund may limit how much capital can exit
valuations may rely on models and appraisals
[Internal link: Interval Funds Explained]
[Internal link: Tender-Offer Funds: Liquidity With Conditions]
Structured products: complexity packaged as simplicity
Structured notes often embed options and can be designed to deliver certain payoff shapes (income, buffers, capped upside).
They can be appropriate in narrow circumstances. They can also be misused as yield vehicles that sell away upside or hide risk.
The due diligence requirement is higher because the risk is in the structure, not just the underlying asset.
[Internal link: Structured Notes in Plain English]
Tokenization: what changes and what doesn’t
Tokenization can change settlement, custody workflow, and market accessibility. It does not automatically solve valuation, liquidity, or fundamental risk.
If a private asset is illiquid, tokenization does not make the underlying asset liquid in an economic sense. It may only make the wrapper tradable, sometimes with wide spreads and fragile market depth.
[Internal link: Tokenized Assets: What’s Real vs Marketing]
Portfolio Role and Sizing: When Alternatives Help (and When They Don’t)
The most important alternative-investing decision is not which alternative. It’s whether the portfolio needs an alternative sleeve at all.
Start with the portfolio problem, not the product
Alternatives are tools. Tools should solve specific problems.
Common legitimate problems:
Concentration in equity risk with limited drawdown tolerance
Concern about inflation regimes (with an honest time horizon)
Desire for crisis diversification (accepting long dry spells)
Need for diversified income sources (with realistic credit risk)
If you cannot name the problem, you are likely buying complexity.
Satellite, not core
For most investors, alternatives—if used—belong in a satellite sleeve around a disciplined core of diversified public stocks and bonds.
The core does the heavy lifting:
broad market exposure
low fees
transparent benchmarking
easy rebalancing
consistent behavior aligned with long-term compounding
The satellite should be limited in size so mistakes don’t dominate the portfolio.
Sizing: small allocations with clear rules
There is no universal “right” percentage. A rules-based approach tends to look like:
Start small
Cap exposure
Avoid stacking multiple complex alts at once
Favor simplicity of return drivers
Match liquidity terms to your horizon
If an alternative requires perfect timing to help, it’s not a portfolio tool. It’s a bet.
Funding matters: what are you reducing?
An alternative allocation is not free. You’re funding it from something else.
Funding from equities may reduce long-run growth potential.
Funding from bonds may increase drawdown risk in recessions.
Funding from cash may reduce near-term flexibility.
A disciplined allocation states the tradeoff explicitly.
[Internal link: What to Cut to Fund an Alternative Sleeve]
[Internal link: Alternatives as Satellite, Not Core]
[Internal link: How Much in Alternatives Is Reasonable?]
Rebalancing and patience
Alternatives often come with long stretches of underperformance. That’s not automatically a failure; it’s often the price of diversification.
The real failure mode is behavioral:
buying after a strong run
selling after a disappointing stretch
abandoning the holding period that made the thesis plausible
If you can’t hold through the strategy’s “normal disappointment,” you shouldn’t allocate.
[Internal link: Rebalancing Alternatives: Rules That Prevent Regret]
Common Mistakes and Behavioral Traps
Most alternative-investing mistakes are not analytical errors. They are expectation errors.
Mistake 1: treating “alternative” as automatically safer or smarter
Alternatives are not inherently defensive. Many contain leverage, credit risk, equity exposure, or liquidity risk. The label is not protection.
Mistake 2: buying the hedge after it worked
Investors often add gold after inflation spikes, add trend after crisis periods, or add private credit after spreads compress. The behavioral pattern is predictable: buy what recently provided comfort.
A hedge purchased for emotional relief is often purchased too late.
Mistake 3: chasing yield without naming the risk
High yields are never free. They are compensation for something:
credit risk
liquidity risk
volatility risk
structural complexity
The discipline is asking: what am I being paid to bear?
Mistake 4: mistaking smooth statements for low risk
Appraised pricing can create a calm return stream that is more about reporting conventions than economic reality. Investors then over-allocate because “it’s stable.”
Stability that relies on limited price discovery is not the same as stability.
Mistake 5: using alternatives to avoid fixing basics
If your portfolio is undiversified, your savings rate is inconsistent, or your time horizon is unclear, alternatives won’t solve those problems. They often distract from them.
Many portfolios improve more from:
simpler diversification
consistent contributions
sensible rebalancing
lower costs than from adding a complex sleeve.
[Internal link: The ‘Uncorrelated’ Trap]
[Internal link: Yield Chasing in Private Credit]
[Internal link: Complexity as a Substitute for Discipline]
The Decision Framework: A Simple Yes/No Filter for Alternatives
Most investors don’t need a complicated process. They need a process that says “no” more often than “yes.”
Use this framework as a final gate.
Step 1: Can I explain the return driver in one sentence?
If not, stop.
You’re not rejecting the asset. You’re rejecting your current understanding.
Step 2: What portfolio problem does this solve?
Name the problem precisely:
inflation regime risk
equity drawdown risk
income diversification
concentration reduction
If the answer is “better returns,” treat that as a red flag unless you have unusually strong evidence and a realistic assessment of fees and access.
Step 3: Are fees and frictions acceptable for the benefit?
If the expected benefit is small, costs matter more. If costs are uncertain, assume they will be higher than you’d like.
Step 4: Is the liquidity contract aligned with my time horizon?
If the asset is illiquid, you must be able to hold through stress without needing the capital. If the fund offers liquidity while holding illiquid assets, understand the terms and the failure modes.
Step 5: Do I have a benchmark and an evaluation window?
Without a benchmark, you’ll evaluate emotionally. Without a window, you’ll abandon the allocation at the wrong time.
Write down:
what success looks like
what disappointment looks like
how long you’re willing to be disappointed
Step 6: If this underperforms for 5–10 years, can I stick with it?
This is the real test. Many alternatives have long droughts. If you can’t tolerate that, your allocation size is too big—or the allocation shouldn’t exist.
A disciplined outcome is often:
keep a simple core
add no alternatives
accept that simplicity reduces decision risk
That is not a lack of sophistication. It is a preference for robustness.
[Internal link: Alternative Investment Flowchart]
[Internal link: How to Write an Investment Policy for an Alt Sleeve]
[Internal link: Benchmarks and Holding Periods for Alternatives]
Closing philosophy: Diversification or distraction?
Alternatives are not automatically smarter than traditional assets. They are different exposures packaged with different frictions. When an alternative solves a specific portfolio problem—and you can justify its fees, understand its liquidity, and commit to its holding period—it can belong as a small, rules-based sleeve.
When an alternative exists mainly to make investing feel more sophisticated, it is usually a distraction.
Long-term investing is not a search for more opportunities. It is a commitment to fewer decisions, made better, repeated for a long time.
If you want more clarity like this—frameworks that reduce noise and increase consistency—subscribe to the Investing Overload newsletter. One calm note at a time, focused on decision-making that holds up across market cycles.