Alternative investments do not belong to conventional investment categories such as stocks or bonds; rather, they represent a diverse range of financial assets, such as private equity, private credit, hedge funds, real estate, venture capital, commodities, and collectables.

These assets have grown in popularity in recent years, especially as investors seek to diversify their portfolios by allocating a portion to alternative investments to enhance their long-term investment approach.

Not only do alternative investments have the potential to diversify a portfolio of traditional assets but often deliver performance that is not correlated to traditional markets, helping investors navigate volatility.

According to recent industry reports, the alternative assets market in India, currently estimated at $400 billion AUM, is projected to grow 5x to $2 trillion over the next decade.

Globally, the alternative investment market has reached an estimated $25 trillion AUM and continues to expand as the investor base and their allocations to private markets increase. Even though India now stands as the world’s fourth-largest economy, alternative investments remain underpenetrated at just 4% of GDP, compared to over 10% of GDP in mature markets like the US and Europe, with investors allocating as much as 20% of their portfolio to alternatives.

This gap presents a significant growth opportunity in India, especially as family offices, high-net-worth individuals (HNIs), and ultra-HNIs increasingly seek non-traditional, higher-yield assets.

Indian investors are participating in alternative investments through allocation to AIFs (Alternative Investment Funds), REITs (Real Estate Investment Trusts), InvITs (Infrastructure Investment Trusts), offshore opportunities through GIFT City-based funds and international platforms.

Each asset category has unique characteristics in terms of expected return, risk, yield, liquidity, and capital requirements that require a closer look to better understand the different benefits that it can bring to a portfolio.

While some of the asset categories may serve more of a growth and capital appreciation purpose, others may protect portfolios against inflation and/or provide stable income, while some strategies may offer a combination of both.

Over the years, alternative investments have offered return premiums to investors who were willing to accept greater illiquidity and have been shown to meaningfully outperform public markets over time.

While access to AIFs has been driven by a mix of macroeconomic, regulatory, and technological forces, the asset class can present its own challenges, requiring an in-depth understanding of the space to evaluate and choose alternatives suitable for investors’ risk profiles.

Our team harnesses its global knowledge and experience to carefully curate a set of high-conviction investment strategies in the alternatives space, designed to help investors in appropriate capital allocation.

Investors who are starting their journey in the alternatives market can start with shorter-tenured private equity funds, such as those with an average life of five to seven years, which invest in stable businesses with predictable exit scenarios, and private credit funds, which generate cash yield.

This allocation can be enhanced to long-tenure equity funds of eight to ten years, investing in stellar fund managers with a track record in the fund’s investment strategy.

There are many nuances in the selection of the fund manager, including, but not limited to, characteristics like having skin in the game, the ability to leverage their experience to back transformational companies poised for growth, the ability to navigate the market dynamics supporting the portfolio companies, and the ability to generate alpha over the investment horizon.

Despite the steady growth in alternative investments, one setback in the past few years has been a slowdown in liquidity avenues for AIF investors due to delayed exit options of the underlying portfolio entities of these AIFs.

This is expected to improve in the following years as many of these entities will use vibrant capital markets, possibly secondary markets with wider participation, and offer opportunities for investor exits.

Investors who thoughtfully allocate to alternatives – balancing risk, liquidity, and long-term vision – could benefit significantly in the next decade.

The author, Rajini Vislavath, is the CIO of Alternative Investment at LGT Wealth India.

The question assumes that nothing is going to change. That’s not likely to be the case, though.

As always, The Motley Fool cannot and does not provide personalized investing or financial advice. This information is for informational and educational purposes only and is not a substitute for professional financial advice. Always seek the guidance of a qualified financial advisor for any questions regarding your personal financial situation. If you’d like to submit your question for feedback, you can do so here.

Do you own the Schwab U.S. Dividend Equity ETF (SCHD -0.48%), and if so, have you been disappointed by its recent performance?

If your answer to both questions is yes, you’re not alone. Plenty of people have been frustrated with its lack of progress versus the broader market. One of these disappointed investors recently asked an entire Reddit community about this fund’s usefulness when there are so many other options available.

There’s always more to the story than anyone can know through a single Reddit post. Since many investors are likely grappling with this very same question, however, some thoughts on the matter are in order.

Different purposes lead to different results

First, you’re not imagining things. As the original poster’s math suggests, SCHD is trailing alternative exchange-traded funds (ETFs) like the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ 0.33%) or the SPDR S&P 500 ETF Trust (SPY -0.04%). Indeed, even adding its sizable dividend payments (its trailing yield is just under 4%) into the mix, the Schwab fund has consistently underperformed SPY and JEPQ since the middle of 2023.

This doesn’t necessarily mean a fund like the Schwab U.S. Dividend Equity ETF doesn’t belong in your portfolio, though.

Yes, Schwab’s dividend fund is lagging. It has for a while. There’s an underappreciated reason for that. The Dow Jones U.S. Dividend 100™ Index that it is meant to mirror holds a bunch of the market’s very biggest dividend payers that have been out of favor for a couple of years now. The fund — and index — are highly exposed to consumer goods names like Altria, oil and gas giants such as Chevron, and industrial tech stocks like Texas Instruments.

These are all fine companies. But they’ve just not been what investors have been clamoring for over the course of the past few years. Investors are still mostly in love with technology stocks that are heavily exposed to the artificial intelligence (AI) revolution. That’s a big reason the JPMorgan Nasdaq Equity Premium Income ETF has done so well since 2023, when the AI movement really took hold.

As the name suggests, JPMorgan’s Nasdaq Equity Premium Income fund holds the same stocks you’ll find in the Nasdaq-100 Index. They include Nvidia, Microsoft, and Broadcom, just to name a few.

There’s a slight twist with JEPQ. Its primary purpose is to generate distributable income to its owners by selling “covered” call options against the stocks the fund holds. The strategy for achieving this usually works quite well, too. The ETF’s current annualized dividend yield stands at an impressive 14.5%.

Make no mistake — this strategy also ultimately means that this fund’s performance trails the Nasdaq-100’s. It’s just an attractive investment because so much of the Nasdaq-100’s gains are still able to be collected in the form of immediate and perpetual income.

It’s a completely different kind of investment than the Schwab U.S. Dividend Equity ETF, so its net performance should be different.

The same can be said of SPY. This ETF is neither dividend-oriented nor growth-oriented. It’s just meant to mirror the performance of the S&P 500, which encompasses 85% of the U.S. stock market’s total market capitalization. That’s why it’s such a good market barometer.

Of course, the same AI-centric technology names that dominate the Nasdaq-100 also dominate the S&P 500. That’s why it’s also outperformed SCHD for the past couple of years.

Expect change … sooner or later, to some degree

So what? Performance is performance, after all, and JEPQ and SPY are performing when Schwab’s U.S. Dividend Equity ETF isn’t.

The reason you diversify isn’t to capitalize on current leadership. You diversify because you have no idea what the future holds, and your job as an investor is to maximize your potential upside while minimizing your risk of the unknown. More to the point, although the JPMorgan Nasdaq Equity Premium Income ETF and the SPDR S&P 500 ETF Trust may be leading the Schwab U.S. Dividend Equity ETF right now, that could change in an instant.

That possibility is more real right now than you might realize, given the environment.

While selling (or “writing”) covered call options on the Nasdaq-100’s stocks has worked well enough since 2023, the market’s somewhat choppy sideways to slightly bullish trend favors this strategy. That’s especially true in an environment with above-average volatility and rising interest rates, as we’ve seen lately. This rise in interest rates also works against dividend stocks, since the market will adjust their prices lower to push their dividend yields closer to bonds’ yields. Given this, it’s not surprising that SCHD has underperformed of late.

But what if everything about this backdrop reverses? What if interest rates start to sink and/or the market’s volatility starts mellowing out? Or what if a strong marketwide bull market takes hold? This situation would favor dividend stocks again, but also make JPMorgan’s option-writing strategy even more difficult to execute, and relatively less productive than simply buying and holding.

You won’t see this shift coming before it happens. You’ll only see it after the fact, when SCHD starts to perform better, and JEPQ starts to perform worse.

Managing risk is just as important as finding reward

This isn’t to suggest that JPMorgan’s covered call ETFs aren’t worth owning, nor is it a guarantee that Schwab’s dividend ETF is on the verge of recovery. That’s the point. While an environmental shift is likely, we can’t know when or to what extent it will take shape. That’s why you remain diversified even when it’s difficult to stick with a laggard and not double down on leaders. You’re preparing for all possibilities by owning a little of everything, and not too much of anything.

It’s also worth considering that one year’s time isn’t actually very long when it comes to stocks. It may be too soon to come to a sweeping long-term conclusion here.

That being said, in this particular instance, two of the three exchange-traded funds in focus are at the extreme opposite ends of the spectrum. There may be room for something else in between that isn’t quite so dividend-oriented, but also not so tech-centric.

For instance, while its dividend yield may be a modest 1.7%, the Vanguard Dividend Appreciation ETF (VIG -0.23%) is based on the S&P U.S. Dividend Growers Index, which makes a point of not including the highest-yielding stocks just because they’re more likely to underperform. Sure enough, this dividend fund has easily outperformed SCHD for the past couple of years. Even if it hasn’t quite kept pace with JEPQ, it’s at least been respectably close.

High-quality dividend stocks do offer the capital growth that most investors also want. They do better in times of market weakness too, since their cash dividend payments usually remain unfazed.

VIG is just one of several other ETFs that might be worth considering here, however. The Vanguard Growth ETF (VUG 0.38%) wouldn’t be a bad bet either, if income isn’t actually an immediate concern.

When a portfolio is well-diversified (as it should be) to protect an investor from the unknowable, the unexpected, and the unpredictable, one of those holdings is always going to lag. That’s OK. That’s the reasonable price you pay for the protection.

What is the Labor Department thinking?

The U.S. Department of Labor (DOL) just rescinded 2022 guidance that discouraged fiduciaries from including cryptocurrency options, such as bitcoin, in 401(k) retirement plans. DOL said that it was just taking the agency’s thumb off the scale and was “neither endorsing, nor disapproving of” fiduciaries who decide to include crypto options on their 401(k) menu. But, come on, why would DOL go to all this trouble if not to boost the inclusion of bitcoin and other cryptocurrencies in 401(k)s accounts?

Bitcoin in 401(k)s is a terrible idea. Participants don’t understand the product, it’s a speculative and volatile investment, straying from traditional investments is unlikely to enhance returns, and it’s probably not a prudent option for 401(k)s.

A lot of hype – and confusion

Bitcoin receives a lot of hype, but people don’t understand what it is. It is a weird product. It is a form of digital currency that uses blockchain technology to support transactions between users, but that currency also has a value that appears to fluctuate significantly. Warren Buffett famously said he wouldn’t buy all the bitcoin in the world for $25. Bitcoin doesn’t produce any cash flow, so it doesn’t generate any returns for the investors. The only way investors can generate a profit is to sell it back for a higher price. It’s much more like gambling than a productive investment.

For some that gambling has paid off (see Figure 1). But it’s been a wild ride. And it’s not clear where it goes from here.

You could do better in an index fund

What is pretty clear, however, is that moving away from traditional stocks and bonds does not necessarily lead to higher returns. Several studies have looked at the investment performance of state and local pension plans, which have increasingly shifted from traditional assets to alternatives, such as private equities, hedge funds, real estate, and commodities and compared that performance to returns from a hypothetical indexed portfolio of 60 percent stocks and 40 percent bonds. Research has found that public pensions could get higher after-fee returns by investing in the passive index fund. The most comprehensive assessment, which finds no gains from alternatives over the entire period from 2000 to the present, shows large shortfalls since the global financial crisis. In short, no evidence exists that exotica produces higher returns, and it could well hurt.

Too risky for 401(k) plans

Finally, at least one expert argues that on legal grounds bitcoin should not be offered in 401(k)s at this time. To satisfy ERISA’s fiduciary standards, the threshold consideration is the general acceptability of the asset class to a broad group of investors. In this case, the most relevant broad group of investors would be the trustees of defined benefit plans. Most defined benefit plans do not invest in bitcoin. And 401(k) trustees should be more cautious in terms of investments than trustees of defined benefit plans. Defined benefit plans involve large piles of capital managed by professional fiduciaries with long time horizons; 401(k) plans involve small accounts managed by unsophisticated investors with shorter time horizons. It makes no sense to offer an asset class to 401(k) participants before it has been accepted by the professional trustees of defined benefit plans.

In short, adding bitcoin to the menu of 401(k) plans is not prudent, it introduces unnecessary risk, and it is unlikely to improve returns. DOL should not be opening the door to this type of activity. The agency should be protecting 401(k) participants, not putting retirements in play.

Markus Hansen, portfolio manager and senior research analyst of Vontobel Asset Management, joins WSJ’s Take On the Week podcast to talk about whether household beverage and food brands, like Coca-Cola, Oreo and Pringles, are the ultimate recession trade. Photo: WSJ

Wall Street wants your nest egg in the worst possible way.

Workplace retirement plans in the U.S., including 401(k)s, hold at least $12.4 trillion. For private-asset titans like Apollo Global Management, Blackstone and KKR this is the world’s biggest untapped market.

These sellers of “alternative investments”—non-traded assets like private-equity and private-debt funds, venture capital, hedge funds, infrastructure, real estate and so on—are struggling to attract more institutional investors to their funds. So they are scrambling to tie up with firms that specialize in reaching retirement savers, such as Vanguard Group and 401(k) specialist Empower.

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To which I will say, until I’m blue in the face: Not so fast.

Are private assets superior to public investments like stocks and bonds? Sometimes—when they’re priced to compensate you for your inability to trade them whenever you want.

That “illiquidity premium” used to be the biggest advantage of alternative investments, according to the pioneer in the field, the late David Swensen, who managed the Yale University endowment brilliantly until his death in 2021.

When you cram illiquid assets into a liquid package, though, you negate that argument—and all kinds of weird things can happen.

To see what I mean, look at Redwood Private Real Estate Debt Fund, a $376 million basket of short-term commercial-property loans run by Redwood Investment Management in Scottsdale, Ariz.

Kerkez / Getty Images/iStockphoto

President Donald Trump is reportedly planning to open the door for retirement plans like 401(k) plans to include private equity and other alternative assets. While the move may favor high-net-worth investors, what could it mean for the average American saver?

Find Out: I’m a Financial Expert: This Is the No. 1 Mistake Americans Make With Their 401(k)

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Experts explained what it means, the pros and cons and whether the average retirement saver should look to make this move if it opens up.

How Trump’s New Move Could Expand Investment Options

At first glance, this move could be positive, according to Chad D. Cummings, Esq., CEO at Cummings & Cummings Law.

“Everyday workers might be able to invest in private companies and other assets not traded on public exchanges. The average 401(k) investor could potentially see higher returns.”

Learn More: The 1 Thing You Can’t Do With Your Required Minimum Distributions in Retirement

But Not Immediately — and With Trade-Offs

The key word here is potentially. With greater returns comes the trade-off of greater risks, and “much less visibility of the underlying asset performance since the assets are not publicly traded,” Cummings warned.

Additionally, the average 401(k) investor would not likely see these available options for months or even a year, because all investment options for 401(k) plans must first be established through the Department of Labor (DOL) regulations.

Risks of Private Equity in Retirement Accounts

While private equity may sound like an exciting new vista to tap, according to Bill Harris, former CEO of TurboTax, founding CEO of PayPal and founder of Personal Capital, “Private equity funds do not belong in the 401(k) of an ordinary investor.”

The biggest downside is the high fees that managing this kind of equity tends to bring with it at a time when, “the average 401(k) plans are finally moving from higher-fee mutual funds to lower-fee ETFs,” he said. “[This] is the wrong time to go the other direction.”

Your Gains Could Be Taxed at a Higher Rate

Additionally, distributions from private equity funds are typically treated as long-term capital gains, which are taxed at a maximum federal tax rate of 20%, Harris said. That is, unless you hold them in a tax-deferred account like a 401(k), in which case, “the gains are automatically converted to ordinary income, which is taxed at a maximum federal tax rate of 37%.”

“The kicker is that PE funds are illiquid, which means you often can’t get your money out for up to 10 years,” Harris said.