What Are Alternative Fixed-Income Investments?

Alternative fixed-income investments can offer a diverse range of options beyond traditional bonds, allowing investors to generate regular income with different risk profiles. These investments typically include assets like real estate investment trusts (REITs), private credit funds and infrastructure projects, which are all designed to offer yields that may outperform conventional fixed-income securities. If you are thinking about adding these investments to your portfolio, a financial advisor can help you determine whether they are a good fit.

Understanding Alternative Investments

Alternative investments refer to assets beyond traditional stocks, bonds and cash. These investments can include commodities, real estate, hedge funds, private equity and infrastructure.

While many alternative investments focus on growth, some are designed to generate steady income. These are known as alternative fixed-income investments . These assets offer investors a different way to receive regular returns, often with the potential for higher yields and diversification benefits.

Types of Alternative Fixed-Income Investments

There are several common types of alternative fixed-income investments. Here are six common ones to consider when building a diversified portfolio .

Real Estate Investment Trusts (REITs)

Real estate investment trusts are a popular alternative for those seeking fixed-income with an additional layer of diversification. REITs are companies that own, operate or finance real estate assets that produce income, such as commercial properties or apartment buildings. Investors earn income through dividends, which are paid from rental revenue or profits from property sales.

REITs are generally traded on public exchanges, offering liquidity that other real estate investments can lack. However, they can be sensitive to interest rates and market conditions.

Private Credit Funds

Private credit funds supply companies with loans when they may not have access to traditional bank financing. These loans often come with higher interest rates, offering investors a potentially higher yield. Private credit can appeal to investors seeking income, as it typically includes structured debt, such as mezzanine financing or direct lending. Unlike publicly traded bonds, private credit is less liquid, and investors may need to commit capital for several years. The illiquid nature of private credit can be a downside, but it also means less exposure to short-term market fluctuations.

Infrastructure Investments

Infrastructure investments , such as toll roads, airports and energy projects, generate stable, long-term income through user fees or government contracts. These projects often have predictable cash flows, making them an attractive option for fixed-income investors. Infrastructure funds pool capital to invest in these large-scale projects, providing exposure to assets that are typically inaccessible to individual investors.

The long-term nature of infrastructure investments offers stability, but they also require a higher level of capital commitment and patience.

Collateralized Loan Obligations (CLOs)

Collateralized loan obligations (CLOs) are another alternative fixed-income option. CLOs are securities backed by a pool of corporate loans, typically to companies with lower credit ratings. Investors receive regular interest payments based on the cash flow generated by the underlying loans. CLOs offer higher yields than traditional bonds but come with higher risks, especially in the event of loan defaults.

While CLOs can be complex, they have become a popular choice for sophisticated investors seeking to diversify their income streams.

Mortgage-Backed Securities (MBS)

Mortgage-backed securities (MBS) are bonds secured by pools of residential or commercial mortgages. Investors receive regular payments derived from the interest and principal on the underlying loans. MBS can offer attractive yields, especially compared to government bonds. However, they carry unique risks, such as prepayment risk. This is when homeowners pay off their mortgages early, thus reducing the overall returns.

Investors should carefully assess the risk factors associated with mortgage-backed securities before adding them to their portfolios.

Peer-to-Peer Lending

Peer-to-peer (P2P) lending connects borrowers and investors directly through online platforms. Investors fund loans for individuals or businesses, and they receive regular interest payments in return. The appeal of P2P lending lies in the potential for higher returns than traditional bonds, depending on the borrower's risk profile. While these investments can offer attractive yields, they also come with risks, such as the possibility of borrower default. To mitigate these risks, it is crucial to diversify across multiple loans.

Reasons to Invest in Alternative Fixed-Income

Alternative fixed-income investments offer several advantages that make them an appealing option for investors looking to diversify their portfolios and benefit from higher yields. Here are six general benefits of investing in alternative fixed-income options:

• Higher yields : Many alternative fixed-income investments, such as private debt, offer the potential for higher yields compared to traditional bonds or savings accounts.
• Diversification : By adding investments like real estate investment trusts (REITs) or infrastructure funds, investors can spread their risk across various asset classes and reduce reliance on the stock or bond markets.
• Inflation protection : Certain alternative investments, like infrastructure projects or commodities, can protect against inflation, as they often increase in value along with rising prices.
• Lower correlation to traditional markets : Some alternatives, such as private debt or peer-to-peer lending, may perform independently of broader market fluctuations, offering a way to reduce overall portfolio volatility.

Risks of Alternative Fixed-Income Investments

Alternative fixed-income investments also carry risks that differ from traditional bonds or savings accounts. Here are four general ones to look out for:

• Liquidity : Unlike traditional bonds, which can be sold easily, some alternative investments like private debt funds or real estate investment trusts (REITs) may be harder to sell quickly, especially in a market downturn . This lack of liquidity can limit an investor's access to cash when needed.
• Less oversight : Peer-to-peer lending platforms or private credit funds may be subject to less scrutiny, increasing the risk of fraud or mismanagement.
• Market risk : These investments can be more sensitive to economic shifts, interest rate changes or sector-specific downturns.
• Higher fees and transaction costs : Alternative fixed-income can have higher fees and transaction costs, which may eat away at returns over time.

Bottom Line

Alternative fixed-income investments can be a lucrative addition to your portfolio, but they are not without risks. If you can withstand the economic shifts and challenges of liquidity, they are an excellent way to diversify your holdings with the opportunity for higher earnings than other investment vehicles. Alternative fixed-income investments like REITs, private credit funds and infrastructure investments can offer different options beyond traditional stocks and bonds.

Tips for Investment Planning

• If you want to create or build out your investment portfolio, a financial advisor can help you analyze and manage investments. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• To determine how much your portfolio could be worth at a future date, use SmartAsset's investment calculator to help you get an estimate .

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