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Alternatives not a scary option after all

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To investors, the words "alternative investments" often rank alongside scary terms like "market crash" and "busted bubble."

But alternatives increasingly are being employed by financial advisors in sound investment portfolios. Many advisors pointedly learned the importance of alternatives during the 2008 financial crisis, when client assets suffered sharp declines in value. Some drops, depending on specific investments, clocked in at as much as 50 percent.

"Advisors realized they needed to mitigate that kind of drop," said Nadia Papagiannis, director of alternative fund research at Morningstar, an independent investment research firm. "They became more aware of risk in [client] portfolios."

(Read more: Using alternative strategies for average investors)

Defining alternatives is tricky. Some advisors view them as anything that falls outside traditional investments, such as bonds and publicly traded equities; others say they are investments whose role is to zig when the broader market zags—investments that mitigate portfolio volatility or hedge against potential downsides.

Alternative mutual funds account for just under 6 percent of mutual fund assets, according to Morningstar. But through the first nine months of 2013, they have sucked up nearly 14 percent of new money getting parked in mutual funds.

Generally, advisors agree that if used properly, alternatives' role in portfolios can be as important as the more familiar stocks and bonds. Broadly, alternatives can range from hedge funds and private equity funds to commodities and some exchange-traded funds (ETFs) and non-publicly traded real estate investment trusts (REITs).

But beware: Advisors also caution that alternatives are complex to understand.

(Read more: The pros and cons of non-traded REITs)

Even financial advisors themselves seek education. A survey released late last month by Natixis Global Asset Management shows that 89 percent of advisors use alternatives at least occasionally, but only 25 percent report using them regularly.

The top reasons given for not using alternative strategies more broadly are that advisors stick to what they can explain to clients (44 percent) and that clients believe alternatives are risky (44 percent).

"Advisors are … looking for education and other supportive [efforts] that can help them be more confident in positioning alternatives in portfolios." -Gary Gallagher, Senior vice president of investment products, Fidelity Institutional Wealth Services

Certified financial planner Clark Randall, founder and owner of fee-based planning firm Financial Enlightenment, points out that investors are scarred from hearing about high-profile debacles such as hedge-fund manager Bernie Madoff's investments, which in 2008 turned out to be a scam of dire proportions.

"Unregulated hedge funds got all the publicity," Randall said. But he emphasizes that employing a hedging strategy is different from using a traditional hedge fund.

Not surprisingly, investment management firms are recognizing the growing interest in alternatives among advisors.

(Read more: Individual investors have alternative options)

In October, Fidelity Investments launched what it dubbed its Alternative Investments Network. Essentially, it will make alternatives such as hedge funds, private equity funds and alternative mutual funds available to its institutional clients, which include registered investment advisors, broker-dealers and family offices.

"One of the primary reasons we're offering this is to help and enable [advisors] to feel confident in embracing alternatives in their client portfolios," said Gary Gallagher, senior vice president of investment products at Fidelity Institutional Wealth Services. "Advisors are … looking for education and other supportive [efforts] that can help them be more confident in positioning alternatives in portfolios."

The Fidelity network will offer education resources for advisors.

Certified financial planner Catherine Valega, owner of Green Bridge Wealth Management, uses alternatives in her client portfolios but bases her conversations about alternatives on client understanding or interest in the underpinnings of the market.

(Read more: Commodities can be a portfolio hedge)

"For about 80 percent of the client base, you stick to plain vanilla alternatives, such as ETFs, REIT mutual funds or long-short mutual funds," Valega said.

She, like other advisors, stresses the importance of securing professional advice when it comes to alternatives. "In all honesty, everyone should be talking to an advisor," Valega said.

—By Sarah O'Brien, Special to CNBC.com

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Alternative Investing 2012