Why add alternative investments to a portfolio?

10/02/2025

Based on several researches wealhy families allocate a significant part of their portfolios to alternative investments. Depending on the study the wealhy families allocate from 25% to 50% to alternative investments.

Firstly, let´s clarify what alternatives include. Generally, it is all investments except stocks, bonds and cash, such as:

  • Hedge funds
  • Real estates (direct ownership or REITs)
  • Private equity (direct investments or fund of funds)
  • Private debt
  • Niche asset classes (litigation finance, life settlements, cat-bonds, ...)
  • Gold and precious metals
  • Commodities
  • Art and antiques
  • Digital assets and cryptocurrencies
  • And many others


Imagine that you have a portfolio of traditional investments only and you add alternative investments there. Below stated chart shows what happens with your expected return and volatility (risk) of your overall portfolio.

If you see this chart for the first time then it seems like a magic! Your expected return is higher and your risk lower! Now, you know the secret why wealthy families allocate a significant part of their investments to alternative asset classes.


The potential for greater returns

Considering a standard portfolio of 60% stocks and 40% bonds we can see on the below stated chart that adding 30% of alternatives to the portfolio with the final allocation of 40% stocks, 30% bonds and 30% alternatives results in:

  • a change of the annual returns from 8.16% to 8.87% so our returns were higher by 8.70% (+0.71% p.a.); and

  • a change of volatility from 9.70% to 8.02% so our volatility decreased by 17.32%



Annualized volatility and returns for more than 30 years period (1989-3Q2022):

Source: Heirloominvesting.com (https://heirloominvesting.com/exploring-alternative-investing-means-finding-the-genuine-alternative/) and Bloomberg, Burgiss, HRFI, NCREIF, Standard & Poor´s, FactSet, J.P. Morgan Asset Management. Alts include hedge funds, real estate and private equity, with each receiving an equal weight. Portfolios are rebalanced at the start of the year. Data is based on availability as of February 28, 2023.


I hope that this theory was not boring for you, but it is particular important to understand why alternative investments should be in our portfolios and what impact it has for a risk and return of the overall portfolio.

If you would like to check a real example how alternative investments help to overall portfolio I would recommend reading this article about "The Yale Model" also known as "David Swensen Portfolio" about Yale University Endowment Fund.

We will definitely come back to alternative investments in detail and discover niche asset classes, current opportunities and much more.