Why Alternative Investments Should Be Limited to Absolute Return Strategies
1 SEPT, 2026
The term alternative investment has become increasingly broad, encompassing private equity, private credit, infrastructure, real estate, hedge funds, and other non-traditional asset classes. However, this expansive definition risks obscuring the original purpose of alternatives in a diversified portfolio.
A more rigorous definition would restrict alternative investments to absolute return strategies, whose performance is fundamentally independent of the direction of equity or bond markets. Under this framework, private equity and private credit should not be considered alternative investments, as their returns remain closely linked to traditional market risk factors.
The Essence of True Alternatives
The defining characteristic of a genuine alternative investment is not the legal structure, liquidity profile, or market accessibility of the asset. Rather, it is the source of returns. True alternatives generate performance through manager skill (alpha) or through dynamic management of market exposures, rather than through static exposure to traditional risk premia.
Examples include certain hedge fund strategies (often available in liquid UCITS format) such as market-neutral equity, global macro, relative value arbitrage, and trend-following Commodity Trading Advisors (CTAs). These strategies seek to deliver positive returns regardless of whether stocks or bonds rise or fall.
Their success depends primarily on security selection, trading expertise, risk management, or the ability to adapt exposures as market conditions evolve. In the case of CTAs, returns are often driven by the flexibility of beta. A CTA can be long or short equities, rates, currencies, or commodities depending on prevailing trends. Its performance therefore does not rely on a persistent long exposure to financial markets. This flexibility distinguishes it from traditional investments whose success requires rising asset prices.
The Misclassification of Private Assets
Private equity and private credit are frequently grouped with alternatives because they are illiquid, privately negotiated, and inaccessible to many investors. Yet these characteristics alone do not justify classifying them as alternatives.
Private equity is fundamentally an equity investment. The value of private companies ultimately depends on the same economic drivers that determine public equity valuations: earnings growth, economic activity, financing conditions, and investor risk appetite. Although private equity managers may add value through operational improvements, leverage, or strategic decisions, a substantial portion of returns comes from exposure to the equity risk premium.
Similarly, private credit is fundamentally linked to bond market dynamics. Returns depend on interest rates, credit spreads, default risk, and the health of corporate borrowers. The underlying economic exposures closely resemble those of public fixed-income markets.
Illiquidity Does Not Create Alternative Risk
A common argument for classifying private assets as alternatives is their lower apparent volatility. However, much of this reduced volatility arises from infrequent valuation rather than lower economic risk.
Because private assets are not continuously traded, their prices are not marked to market daily. This creates a smoothing effect that suppresses observed volatility and correlation. If private equity portfolios were priced continuously like public equities, or if private loans were marked daily like public bonds, their risk characteristics would appear much closer to those of traditional markets.
In other words, illiquidity changes the measurement of risk, not the underlying source of risk. Lower reported volatility should not be mistaken for genuine diversification.
A More Meaningful Definition
A useful classification system should focus on return drivers rather than investment structure. Under such a framework, alternative investments would include strategies whose performance is primarily generated by alpha or by flexible, adaptive beta exposures. Their objective is absolute return, independent of market direction.
Private equity and private credit, despite their private ownership and illiquidity, remain fundamentally equity and credit investments. They may offer attractive returns and portfolio benefits, but they do not provide the same type of diversification as true absolute return strategies.
