What You Need to Know About Alternative Investment Funds

October 12, 2021

Who says you’re limited to mutual funds? Here’s a look at how alternative investment funds think outside the box to make your money work for you.

When you picture investing, what comes to mind? Wall Street brokers? Maybe a hedge fund manager?

The truth is, there’s a whole world of investments out there, and as a savvy investor, you’re not limited to conventional investment categories or conventional investment vehicles. In fact, you should branch out from conventional tactics—it strengthens your portfolio in the long-run.

One such tool is alternative investment funds. Here’s what investors need to know to get started.

What are Alternative Investments?

An alternative investment is a category of financial asset that does not fall under one of the three conventional investment categories:

  1. Stocks
  2. Bonds
  3. Cash

This is an extremely broad category that can refer to anything from hedge funds to derivatives contracts to 80-year-old wine. However, generally speaking, alternative assets are more illiquid than their conventional counterparts, since the assets (and transactions involving them) are relatively rare.

But alternative assets are also regarded as an excellent way to diversify your portfolio, since they have very little correlation to the stock market (and often perform in the opposite direction of the stock market). This makes many alternative asset classes an excellent hedge against inflation.

What are Alternative Investment Funds?

Alternative investment funds, often referred to as alternative mutual funds or simply alternative funds, are either mutual funds or exchange-traded funds (EIFs) that use non-traditional trading strategies to non-traditional investments to meet their financial objectives.

In technical terms, this means an alternative investment fund is a collective investment in non-traditional (i.e. alternative) assets achieved by pooling capital from a group of investors. When returns come in, these are also pooled.

To be clear, alternative investment funds may still use conventional assets and techniques, such as stocks and bonds. However, what makes them unique is that they focus on alternative investments as their core investment rather than relying on conventional investments.

Alternative Funds vs. Mutual Funds vs. Hedge Funds

Alternative investment funds work a lot like a mutual fund (a company that pools investments from multiple investors and invests the money in securities like stocks or short-term debt). Alternative funds abide by the same basic structural premise.

The difference between them is that alternative funds often seek to deliver returns through non-conventional investments with a mutual fund would not be allowed to pursue. These funds also rely on more complex trading strategies than mutual funds, and their investment objectives more closely resemble a hedge fund (seeking positive returns even if the stock markets fall, usually at higher risk and higher cost to investors.

In fact, alternative funds share many strategies in common with hedge funds, including:

While you’ll often hear alternative funds and hedge funds discussed in the same sentence, there are two key differences between them.

The first is the Investment Company Act of 1940. This law places legal limitations on mutual funds, including alternative mutual funds, in order to provide legal protections to investors. These rules do not apply to unregistered hedge funds. On one hand, this means investors don’t have the same safeguards, but on the other hand, it allows hedge funds to pursue strategies that mutual funds cannot.

The second is the management fee structure. Most hedge funds rely on the 2/20 performance fee, which represents a 2% management fee applied to the total assets under management (used to pay salaries and operational expenses) and a 20% performance fee on profits the fund generates beyond a minimum threshold, typically 8%. Mutual funds, including alternative funds, are not legally allowed to charge investors this fee.

Again, what makes alternative funds unique is their use of alternative assets to achieve their aims. Regular mutual funds are not allowed to use such assets. Hedge funds are considered a type of alternative investment that takes advantage of stock market opportunities differently than a mutual fund.

Alternative funds use alternative investments as part of their portfolio, such as start-ups, commodities, global real estate, and so on. In fact, alternative funds may use hedge funds as a type of intangible asset for investors.

What to Know Before You Invest

Before you invest in alternative funds, there are a few things to keep in mind.

First, consider the investment objectives of the fund in question. Some funds seek broad diversification. Others seek to capitalize on the specialized expertise of the manager to earn money in a specific market niche.

And on that note, pay attention to the fund manager as well. Like hedge funds, most alternative funds are actively managed (in other words, an actual human being is the one making the decisions). This means it’s absolutely critical to look at the fund manager’s experience and track record. FINRA’s BrokerCheck is an excellent tool for that.

Also, the contents of the fund may be hard to sift through since alternative funds aren’t as transparent as mutual funds. Do your best to understand the fund’s structure, objectives, and what types of investments it holds.

Ready to Diversify Your Portfolio?

One key area for alternative investment funds is art—blue-chip art, that is. And with good reason. According to Artprice, blue-chip art has outperformed the S&P 500 by 180% from 2000–2018, and Deloitte estimates the total value of art to be $1.7 trillion.

Here at Masterworks, we know that blue-chip art holds incredible potential for investors. That’s why we’re here to democratize the blue-chip art market. We’re a top buyer in the art market, with more than $150 million in paintings purchased, backed by expert research in collaboration with Citi Bank, Bank of America, and more. Then, we make art work for you by allowing members to purchase shares in multi-million-dollar art, with $1 million to $30 million in paintings offered roughly every ten days. And when we sell a painting, you get a share of the profits. Ready to put passion investing to work for your financial goals? Submit your membership application today.

Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.