The role alternatives play in a portfolio

Investors do not add alternatives for novelty. They add them to do specific jobs that stocks and bonds cannot always do alone.

The three classic jobs

• Diversification. Because many alternatives are less correlated with equities, they can cushion a portfolio when stock markets fall. The aim is a smoother ride for a given level of return — not necessarily a higher return.
• Inflation protection. Real assets such as gold, commodities, real estate and infrastructure tend to hold or gain value when prices rise, because their worth is tied to physical things rather than to a fixed stream of currency.
• Return enhancement. Some alternatives — private equity, venture capital, certain hedge-fund strategies — aim for returns above what public markets offer, as compensation for taking on illiquidity and complexity.

The trade-off is always there

There is no free lunch. The diversification and return potential are paid for with illiquidity, higher fees, complexity and often higher minimums. A reasonable mental model: alternatives are a complement to a core of low-cost stocks and bonds, not a replacement for it.

How much to hold

There is no single correct figure, and this is educational, not personal advice. Large institutional investors — endowments and pension funds — sometimes hold a quarter or more of their portfolios in alternatives, but they have teams, time horizons measured in decades, and the ability to lock money up. A typical retail investor with shorter horizons and a need for liquidity would normally hold far less, and only money they can genuinely leave untouched. Decide your allocation before you are tempted by any specific product.