Every possible investment choice is either an alternative or a traditional investment. Traditional investments are:

  • long-only, publicly traded investments in stocks;
  • long investments in publicly traded bonds; or
  • cash.

Traditional is not a synonym for “common,” and neither is alternative a synonym for “unusual.”

Alternative Investments

Alternative investments include assets such as:

  • derivatives, such as options, futures or forward contracts, swap contracts, etc;
  • real estate;
  • short-selling stocks;
  • commodities;
  • fine art;
  • racing horses; and
  • anything outside the traditional pool of investment classes.

Alternative investments often supplement traditional investments held in a portfolio. For example, holding a common stock and options on the same stock to protect or enhance investment returns.

A growing market

The growth and popularity of alternative investments proliferated in the 1990s. From hedge fund managers and institutions to high net worth individuals and retail investors, the investment community demanded new alternatives to traditional investments from brokers, banks, and investment dealers.  The market responded with an increased supply and complexity of investment options.

Alternative investments typically have one or more of the following characteristics:

  • illiquidity;
  • narrow expectations from managers;
  • a low correlation of returns with traditional investments;
  • lax regulation;
  • lower transparency;
  • limited historical data;
  • unique tax treatment; and
  • special legal considerations.

Price discovery is often much more difficult for these alternatives than traditional investments such as stocks and bonds traded in the open market.

Question

Which of the following would you describe as a traditional investment?

  1.  The loose change in your pocket
  2.  A promise to buy GM stock at a fixed price one month from today
  3.  Starry Night by Vincent Van Gogh

Solution

The correct answer is A.

Only cash, publicly-traded stocks, and publicly-available bonds are available to investors in traditional investments.

Reading 50 LOS 50a:

compare alternative investments with traditional investments


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