More and more advisers are turning to alternative assets, which include anything beyond plain-vanilla stocks and bonds, as part of a balanced portfolio for their clients.

“Historically, an investment portfolio was 60% stocks and 40% bonds,” said Michael Sheldon, CFA, chief investment officer at RDM Financial Group-Hightower, in Westport, Connecticut. “But in the past few years, more investors have been looking at alternative sources of return that help mute volatility, create more diversity, and create a better risk-adjusted portfolio.”

RDM has a moderate equity portfolio that allocates 15% of assets to five alternative investments. That includes managed futures, gold, a long-short equity fund, a multi-manager/multi-strategy fund, and put options on the S&P 500 to protect against a drop by stocks.

“There are many different types of vehicles for alternative assets, and it’s important to be diversified within this part of the market,” Sheldon said.

Alternative investments help clients stick to their long-term goals, he said.

“One of the hardest things for investors is dealing with volatility," Sheldon says. "Human emotion is powerful and can push investors to cash out at inopportune times.”

The cushioning effect of alternative assets can work to prevent that behavior, Sheldon said.

Ethan Anderson, an adviser at Rehmann Financial in Grand Rapids, Michigan, applies a more tactical strategy for alternative assets.

Although there are times that alternatives can provide balance to a portfolio, “that doesn’t mean there aren’t times when you don’t want them in your portfolio,” he said.

Advisers who think that stocks are overvalued should direct clients to equity alternatives, Anderson said.

“Commodities and real estate are the most traditional equity alternatives," he said. "Precious metals may be part of commodities, but gold trades more like a currency.”

Long-short stock funds represent another equity alternative.

Alternative assets to bonds include long-short bond funds, emerging-market bond funds, bank loan funds, and preferred stocks, Anderson said.

Of course, advisers should be aware of the large risk that many alternative assets carry.

“Alternatives can act differently at different times, so it’s important to look under the hood carefully,” Sheldon said. “Look at how they have done in different market environments, so you have a sense of how they might benefit in the future.”

For example, commodity investments haven’t fared well in recent years.

“Make sure you’re comfortable with the risk profile,” Anderson said.

This story is part of a 30-30 series on building a better portfolio.

Dan Weil

Dan Weil’s work has appeared in The New York Times, The Wall Street Journal, Bloomberg, Institutional Investor and Tennis magazine.