Albert Chu, chief investment officer for Wealthstone in Columbus, Ohio, believes that getting exposure to the asset class is worth the fees in some cases.
"We index our large-cap managers since they tend not to outperform and with those savings we're going to allocate some fee dollars to some of our alternative strategies," he says.
Should you choose to dabble in these alternative investments, be sure to investigate them thoroughly or get some good advice from a trusted adviser.
According to investment research company Morningstar, about 75 mutual funds employ hedging strategies.
"The easiest example of an alternative strategy is going to be a long-short fund or opportunistic equity," says Chu, a chartered financial analyst and chartered alternative investment analyst.
A long-short strategy involves investing in stocks with positive prospects (making long bets) as well as stocks that are expected to decline in value.
"If a portfolio manager has a group of stocks, they're going to go out there and buy their best ideas and hope they rise in value. And that is a long (bet)," Chu says.
Then if they find some challenged companies, the fund managers will short those companies and put together a long-short portfolio.
Here's how short-selling works: The investor can use leverage, by borrowing money on margin from his broker, to borrow the stock at a certain price and sell it to someone else. When the stock price drops, the investor buys the stock at market price, gives it back to the broker and pockets the profit.
Short-selling is a highly risky strategy, because if a stock goes up instead of down as expected, the investor's potential for loss is unlimited.
Long-short funds are the most widely available hedge strategies in mutual funds, and most don't require big minimum investments.
"You're going to have a different return pattern than the overall stock market," says Chu.
Recent history bears this out. Long-short funds outperformed the S&P 500 during the 17-month bear market that ended March 9, 2009. The hedge-like mutual funds lost 15 percent on average while the broad market plummeted 43 percent.
Long-short funds also haven't rebounded as much either. Since March 10, the S&P gained 50 percent through mid-August, while long-short funds advanced 16 percent.
Commodities also may be a good alternative option for the individual investor's portfolio.
"Commodities are worth considering not for returns but because they act like portfolio insurance. By themselves they're very volatile, but when you add them to a portfolio, the historical evidence is that you reduce the risk of the portfolio and get higher risk-adjusted returns," says Larry Swedroe, principal and director of research at Buckingham Asset Management in St. Louis.
That wasn't particularly the case in the most recent bear market, though. According to Morningstar, most commodity indexes did worse than the S&P 500 in 2008, which was down 37 percent for the year. For instance, the natural resources category, which includes gas and oil, took a 48 percent hit.
Swedroe, author of "The Only Guide to Alternative Investments You'll Ever Need," particularly recommends commodities in the form of fully collateralized commodity futures.
Fully collateralized means unleveraged. Commodity futures are speculative financial instruments known as derivatives that are financial contracts written on the future price of a product.
Just like with equities, some commodity funds use long-short strategies in an effort to improve returns. Some commodity funds are actively managed, while other ETFs and mutual funds follow commodity indexes.