Are Alternative Investments Living Up to the Hype?

We've all heard the whispers, perhaps even the enthusiastic shouts, about "alternative investments."

Real estate, private equity, venture capital, hedge funds, collectibles, even the wild world of crypto—they're often painted as the secret sauce for a truly diversified portfolio, promising returns that traditional stocks and bonds simply can't deliver.

The narrative is compelling: imagine investments that march to their own beat, offering a shield against market volatility and a chance for brilliant managers to uncover hidden gems.

But let's hit pause for a moment. Is this vision always the reality?

These are the asset classes that investors (and their advisors) like to name-drop when they want to feel a little more Wall Street and a little less Warren from accounting.

But here’s the kicker: just because something is labeled “alternative” doesn’t mean it’s automatically better—or even different.

In his recent blog post, the legendary finance professor Aswath Damodaran pulls back the velvet rope on the alt-investment club and asks the inconvenient question no one wants to: Are these investments actually doing what they claim to do?

Spoiler: Not really.

🧯 What’s the Promise, Anyway?

Let’s start with the pitch. Alternatives are marketed as:
✅ Low correlation to stocks and bonds (hello, diversification!)
✅ Alpha-generators, offering returns that boring public markets can't match
✅ Crisis buffers—they don’t drop when everything else tanks (allegedly)

Sounds great, right? Who wouldn’t want all the upside with none of the nasty volatility?

But as Damodaran highlights, when you actually peel back the layers, things aren’t as magical as they seem.

📉 The Performance Gap: When Marketing Meets Reality

Damodaran breaks it down brilliantly: there’s a massive difference between how alternative investments are marketed and how they actually behave.

Let’s look at the data he shares:

🔻 Private Equity vs. Public Equity

Over the last two decades, the returns of private equity (PE) have gradually moved closer to those of public markets. In fact, the spread between PE and the S&P 500 has narrowed significantly and not in PE’s favor.

While the 1990s and early 2000s saw double-digit annual outperformance from PE funds, more recent vintages have barely kept pace, especially after fees. According to Damodaran’s analysis:
✅Net returns for PE in the 2010s hovered just 1-2% above public markets.
✅Add in a typical fee structure of 2 and 20, and suddenly that alpha evaporates.

📊 Hedge Funds: The Original Alternative Alpha?

Once seen as the playground of financial rockstars, hedge funds have also stumbled. Damodaran highlights that:

✅From 1998 to 2022, hedge fund returns trailed the S&P 500 in 15 out of 25 years.
✅ Sharpe ratios (a measure of risk-adjusted return) for hedge funds have dropped over time and now look strikingly similar to plain-vanilla equity ETFs.

And yet—they still charge like they’re doing something revolutionary.

🧪 “Uncorrelated”... Until It’s Not

One of the biggest myths around alternatives is that they’re immune to market swings. Damodaran calls this out directly: many alternatives appear uncorrelated simply because they're not priced daily. That’s right—because private investments are often “marked to model,” they look stable… until you actually try to sell them.

When market shocks hit, those low correlations suddenly spike. So much for protection.

His favorite line (and mine):

“There’s many a slip between the cup and the lip.”

Translation? Just because something looks good on a chart doesn't mean it will help when the world goes sideways.

📉 Liquidity: The Hidden Cost You Forgot to Ask About

Liquidity is boring—until you realize you don’t have any.

Damodaran reminds us that most alternative assets lock up capital. You can’t just sell a venture stake or a piece of a leveraged buyout when you need cash. During market stress, this illiquidity turns from a small footnote into a major headache.

He also adds that liquidity risk is rarely priced in. Investors chase performance without properly adjusting for the fact that they may not be able to exit when it matters most.

📈 Are There Still Reasons to Invest in Alternatives?

Yes, but only if you’re clear-eyed.

Damodaran’s not saying you should never touch alternatives. He’s saying you need to know what you're getting into. Alternatives aren't inherently bad—they're just often misunderstood.

So if you’re going to invest, ask yourself:

❓ Are you being compensated for the lack of liquidity?
❓ Are you chasing alpha that’s already been arbitraged away?
❓ Are the fees worth it?
❓ Do you understand how (and when) the asset is priced?

If the answer to most of those questions is “I don’t know” or “my advisor told me it’s hot right now,” maybe pump the brakes.

🚀 Final Thoughts: Use, Don’t Worship

Alternative investments have a place. But they’re not magic. They're tools—complex, often expensive, sometimes illiquid tools—that require careful thought.

Damodaran’s post is a great reminder: don’t let marketing override logic. Past outperformance doesn’t guarantee future results (especially when billions of new dollars flood into those same “underpriced” spaces).

Sometimes, boring works. And sometimes, the real alpha is knowing when to say no thanks.

 
📚 Want to read Damodaran’s full breakdown (with charts and data)?
You can find the original post here:
The (Uncertain) Payoff from Alternative Investments