The person who came up with the moniker “Alternative Assets” was probably not a child of the 1960s. For anyone who remembers that decade, the term Alternative might conjure images of Counter Culture types flirting with illegal substances and eschewing the importance of money and wealth.

This is a pity. While to be Alternative in the 1960s conjures up all sorts of weird and wonderful behaviours, Alternative Assets got their name merely because it was a useful catch-all term for investments that did not fit neatly in the sphere of traditional asset classes.

In fact, many alternative assets are not very alternative-sounding at all. Gold, property, commodities like oil: most retail investors would be familiar with all of these if not, perhaps, the best way to invest in them.

“Alternative” also implies that these assets should completely replace traditional assets, which is incorrect. Alternatives are meant to be an additional source of return in a portfolio which complements exposure to traditional assets such as equities, property and bonds.

What really make alternative assets “alternative” are the unique benefits they bring to a balanced portfolio.

Alternative assets have the potential to provide positive returns when traditional assets are doing poorly. In other words, they offer reliable diversification and used properly can reduce the risk in a portfolio.

Alternative assets often perform better in dysfunctional, volatile markets when traditional asset frequently suffer.

What might be regarded as a weakness in a traditional asset class is often a strength in Alternative assets.

This last point requires elaboration but first, it is useful to separate Alternatives into two categories: Real assets (gold, property etc) and Absolute Return Strategies (managed funds which use a variety of strategies in order to produce positive returns regardless of market direction).

“Some alternatives will have internal dynamics which can withstand or run counter to broader economic trends”

Alternatives assets can be more complex than traditional assets (Absolute return funds) and less liquid (direct property); they can be harder to value (gold) and more difficult to invest in (some commodities).

But these qualities are also central to the case for Alternatives. The connections between these assets and the broader markets and economy are weaker, so they are less influenced by those markets and therefore better diversifiers. Some alternatives will have internal dynamics which can withstand or run counter to broader economic trends (Chinese demand for commodities and volatility-based investments, for example, or the ability of an absolute return manager to short stocks).

Alternative assets can be more difficult to access and are unfamiliar to many people, so the rewards of investing in them tend to be reserved for investors who do their research and who think long term about their investments, instead of chasing the performance of the latest “hot” asset.

Since there is sometimes the absence of a tangible income stream with alternatives, this can make it difficult to articulate expected returns to investors and their relationship with other asset classes. In explaining their value to clients, it is sometimes easier to look at the impact of alternatives over a long period of time at the portfolio level. Here, the difference in performance between a balanced portfolio with and without alternative assets is clear.

The portfolio with alternative assets tends to be less volatile, suffers less drawdown when markets fall, and tends to lead to higher risk-adjusted returns.