When looking at where to invest your money, it’s wise to diversify so that a major market shift is less likely to lead to a massive loss. Investing in an alternative investment exchange-traded fund (ETF) is a more advanced strategy as it takes some time to learn about and understand. But once you get a feel for the nuanced fee structures and have built your portfolio to the point where a slightly riskier investment with less liquidity is feasible for you, these ETFs can offer immense opportunity.
What is an Alternative Investment ETF?
ETFs offer diversity for portfolios with assets that fall outside of cash, stocks and bonds. Some examples of alternatives you might consider include:
- Real estate
- Commodities
- Art or collectibles
- Hedge funds
Historically, these investment classes were only available to wealthy investors. But ETFs have made it possible for the average investor to get involved.
Alternative investments are nothing new. Investors have placed their money in real estate, farmland, peer-to-peer lending, wine and more for years. ETFs just make these investments more attainable for the average investor.
How Does an Alternative ETF Work?
Investors buy and sell alternative ETFs on a stock exchange much like stocks. The difference is in how they are structured. An ETF can track the price of a single commodity or a collection of securities. You can watch the price of ETFs fluctuate throughout a trading day and buy and sell them. Like stocks, investors can short ETFs.
The reason these are popular for portfolio diversification is that they contain multiple assets instead of just one. ETFs can contain a mixture of investment types.
What is the Difference Between Alternative ETFs and Traditional ETFs?
Traditional ETFs are based on stocks, bonds or cash. Alternative ETFs include a larger asset range, including collectibles, art, real estate, private equity and commodities. While alternatives open the door to more diverse portfolios, they are riskier because of their complexity and vulnerabilities.
8 Types of Alternative ETFs
To gain a better understanding of how alternative ETFs work and offer portfolio diversity, here’s a look at the 8 most popular types.
1. Real Estate
Without shelling out hundreds of thousands of dollars on a single property, you can invest in the U.S. real estate market through real estate investment trusts (REITs). Select from a variety of focuses and structures.
2. Commodities and Managed Futures
Commodity ETFs provide the opportunity to invest in items like gold or crude oil. When stocks, bonds and cash experience a downturn, commodities tend to be on the upswing, which helps investors weather challenging markets.
Investing in commodity ETFs is less expensive and cumbersome than holding the actual items because you won’t need storage space or insurance for the goods.
3. Art and Collectibles
Without filling your home with valuable items, you can invest in the production, distribution and sale of art or collectibles. Some ETFs hold the physical assets, while others do not. Some categories of collectibles you can invest in using this strategy include stamps, vintage cards, coins, sports memorabilia or wine.
4. Hedge Funds
Some alternative ETFs offer similar investment strategies to those of hedge funds. These investments are market neutral and event-driven. They can offer short- or long-term equity. The benefit of using an ETF instead of an actual hedge fund is that they offer similar returns but with lower costs and more liquidity.
5. Factor ETFs
When investing in factor ETFs, you’re investing in companies that meet a very specific factor profile. The ETF has specific criteria for selecting these companies and uses a rules-based approach.
6. Options Contracts and Derivatives
Invest in swaps, options and forwards with options contracts and derivatives. This is certainly a more advanced alternative ETF strategy and one that you need to gain a greater understanding of how the market works to employ. Generally, you’ll hold these types of investments for short periods to essentially bet on the well-being of the market.
7. Multi-Assets
Investors can place their money in various assets using multi-asset ETFs. These investments allow for combining the benefits of stocks, bonds, commodities and REITs in one strategy.
8. Alternative Income Strategies
Extend your portfolio beyond traditional fixed-income investments with alternative income strategies. These investments are often based on high-yield bonds, mortgage-backed securities, dividend-paying stocks or preferred securities.
How to Buy an Alternative Investment ETF
Once you’re ready to start investing, follow these steps to begin taking advantage of the diversity alternative investment ETFs can provide.
1. Open a Brokerage Account
Just like you need a brokerage account to invest in the stock market, you’ll need one for ETFs. If you already have a brokerage account, you can use that. Otherwise, you can research providers to find an account that meets your needs, has a favorable fee structure and allows you access to the investments you want to place your money in. Review the list of the best alternative investment platforms to find one that is right for you.
2. Fund Your Account and Confirm Payment Details
Once you have a brokerage account, you need to move funds into it. Most banks allow you to do this electronically as a bank-to-bank transfer. However, you should allow a few days for this process as there will be a confirmation process that often involves transferring a few cents between accounts to confirm the details.
3. Choose the ETF and Execute the Trade
Now it’s time to select a specific alternative ETF and start investing. You might want to invest smaller amounts in various ETFs to further diversify your portfolio. Be sure you understand the structure and returns before executing the trade. You can review a list of alternative ETFs to inform your decisions.
Advantages of Investing in Alternative ETFs
Like any investment strategy, this type of investment has pros and cons. Here’s a look at the reasons to consider alternative ETFs.
Diversification
Gain exposure to various asset types that react to market changes differently than stocks or bonds. That way, when the market shifts for better or for worse, you have investments with low or negative correlations to continue growing your investments even while other investments experience downturns.
Liquidity
Because alternative ETFs trade on the stock exchanges just like traditional investments, you can buy and sell them throughout the trading day. This feature allows you to take advantage of market changes while also moving your money around to various assets when desired.
Accessibility
Investors can access markets and strategies that used to only be available to wealthy investors. ETFs offer everyone access to asset classes and niche sectors that were formerly the sole purview of people with large portfolios and immense cash on hand.
Transparency
ETFs offer investors updates on their holdings daily. That way, investors know the specific assets they are investing in when they purchase the funds and can better understand the risks and potential benefits involved.
Lower Costs
While investors can place their money directly in the assets ETFs involve, it often has a higher expense ratio. This can mean better returns for investors while reducing the barrier to entry for new investors.
Things to Consider with Alternative ETFs
While alternative ETFs offer many outstanding benefits, there are also some drawbacks to consider with this asset class.
Complexity
Investors need to take time to understand the complex underlying investment strategies that an alternative ETF employs. Taking the time to learn this information will help investors ascertain the risks and complete the required due diligence to get the most from the investment.
Volatility
Many alternative investing opportunities are subject to large price fluctuations when compared to traditional assets. Some volatility comes from the fact that you’re investing in sensitive markets with macroeconomic factors.
Tracking Error
Some alternative ETFs may have difficulty accurately tracking the performance of their underlying assets because of factors such as illiquidity or limited availability of certain assets. This can lead to uncertainty for investors, even if they have a clear understanding of how the investment works and the market factors associated with that investment.
Lack of Regulation
Compared to traditional alternative investments, alternative ETFs may have less regulatory oversight. One professor examined the lack of regulation in various index funds and found that there is room for clearer, better regulation around ETFs to protect investors.
Accessing Alternative Investments Through ETFs
While there’s a great deal to learn about alternative ETFs before investing, the time and research are worthwhile. Gaining access to varying assets can help diversify portfolios and help investors grow their assets despite market changes or downturns.
Frequently Asked Questions
Do alternative investment ETFs pay dividends?
Some investment ETFs pay dividends while others do not. Review the terms carefully before investing to better understand the potential return on investment from that particular investment.
Can you hold alternative investment ETFs in your retirement account?
Depending on the type of retirement account you have, you might be able to hold alternative investment ETFs. An IRA can hold most investment types.
Will investing in alternative investment ETFs guarantee high returns?
As is true for any investment, the rate of return on ETFs is not guaranteed. However, ETFs do offer the potential for high returns.
About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.