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Alternative Investments for Today’s Market

Richard Lewis

As bond yields remain mired at record-low levels and equities continue their dance with volatility, many investors have been left out in the cold. With neither stocks nor bonds proving tempting enough for scores of folks to get into the game, a new asset class has taken center stage — alternative investments. Inspired by red-hot historical returns in many corners of the alternative market, investors appear to have been bitten by the alternative bug, pouring billions into this corner of the market over the past several years.

While alternatives are no panacea to many of the shortcomings of stocks and bonds, they can serve as diversifiers within anyone’s portfolio, as well as provide the potential for added returns. Here are a few first-rate funds that you might want to consider if you’re in the market for alternative investments.

All that glitters
When many folks hear the phrase “alternative investment,” they automatically think of gold. After all, the price of gold has skyrocketed in recent years as the global economy fell into the deepest recession in decades. Investors have jumped onto the gold bandwagon en masse, as evidenced by the rapid growth in the SPDR Gold Shares ETF (NYS: GLD) , which now tops out at $67.8 billion in net assets. That makes it the second largest ETF in existence.

And while investors certainly can benefit from a very small allocation to gold, they need to look beyond the shiny metal if they truly want to capture all the diversification and return benefits of owning commodities. To get the most bang for your buck in this asset class, look for an inexpensive exchange-traded fund that tracks a broad commodity index. One of the best options in this space is PowerShares DB Commodity Index Tracking Fund (NYS: DBC) . For a reasonable 0.85% price tag, you’ll get exposure to oil, natural gas, gold, silver, corn, and wheat, among other commodities.

However, if you prefer some active management when it comes to commodity investing, consider a fund such as Harbor Commodity Real Return Fund (HACMX) or T. Rowe Price New Era (PRNEX). Both funds offer exposure to the commodity sector but approach that task in different ways. The Harbor fund employs an enhanced indexing strategy, investing in commodity-linked derivatives to track the performance of a broad basket of commodities.

The T. Rowe Price fund, on the other hand, invests in the stocks of natural resources companies, so your commodity exposure is more indirect. For example, manager Tim Parker added oil well services firm Baker Hughes (NYS: BHI) in the wake of the BP oil spill back in 2010 on the belief that long-term growth in offshore drilling would outweigh the short-term drilling moratorium. Depending on whether you want to invest in commodity-linked derivatives or commodity-related stocks, either of these funds could be a solid addition to your portfolio.

Location, location, location
Real estate is another prime alternative asset class that can add a layer of diversification to a struggling portfolio. One of my favorite actively managed real estate funds is T. Rowe Price Real Estate (TRREX), which has been run by manager David Lee for nearly a decade and a half. Lee takes a steady, consistent approach to finding undervalued real-estate-related names. This fund isn’t flashy, but it gets the job done without taking on excessive levels of risk. And with a low 0.78% price of admission, it’s one of the cheaper actively managed real estate funds around.

ETF investors can find several decent options for real estate investing, including the Vanguard REIT IndexETF (NYS: VNQ) or the iShares Dow Jones US Real Estate ETF (NYS: IYR) . The Vanguard fund wins the award for inexpensive coverage, with a super-low 0.12% expense ratio, while the iShares fund offers a slightly higher yield of 3.5%.

Staying in balance
There are other alternative investments that are a little more difficult for Main Street investors to access, namely private equity or hedge funds. Unfortunately, there still aren’t a whole lot of ways for small-fry investors to directly access these particular strategies, at least not at a reasonable cost. There are a number of “long-short” mutual funds on the market that attempt to combine shorting strategies with long investing.

Unfortunately, the vast majority of these funds tend to do well only during bear markets and have very poor long-term track records. Unless you have a specific need and desire for a bear market fund, most folks would be better off avoiding these types of investments.

While we will almost certainly see more funds and ETFs focusing on alternative investments in the coming years, investors should exercise caution when shopping in this sector. Remember not to chase performance and to examine a fund’s long-term track record, not just the past year or two. Limit yourself to the more inexpensive fund options and don’t dump your investments if the asset class takes a sudden downward bend. Lastly, make sure that alternatives don’t take up too much space in your portfolio — they should be thought of as side dishes, not the main course.

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At the time thisarticle was published Amanda Kishis the Fool’s resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Tryany of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

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