Interest rates are rising, inflation is becoming higher and seemingly more persistent, and many stock markets look expensive by historical standards. It may be an opportune moment to start thinking about incorporating alternative options to diversify and, ideally, inflation-proof an investment portfolio, while adding different sources of potential returns.

More than a decade ago, the world’s central banks adopted rock-bottom interest rates and quantitative easing to bring the global economy back from the brink after the global financial crisis. The Covid-19 pandemic prompted them to double down on easy money, while government policymakers sprinkled the fairy dust of public spending into the mix.

This trend has contributed significantly to a near-uninterrupted 10-year run of rising equity prices. But there is a very real danger that this benign period for stock markets is drawing to a close. Here are some alternative options for your investment portfolio – although be warned, they may entail different risks from conventional financial assets, and they do not benefit from investor protection rules applicable to mainstream securities and investment products.

Luxury goods and collectibles

At times when financial markets appear riskier, tangible objects have a certain appeal, particularly fine wine, works of art or jewellery. Equally, they can be a source of pleasure even if they don’t work out as an investment.

Often, they have performed extremely well, at least over the long term. The Liv-ex Fine Wine 1000 index, the broadest industry benchmark for secondary market prices of high-quality wines from the world’s most prestigious producer regions, was down by 7.6% over the 12 months to July 2023, but it had risen by nearly 25% over the previous five years. The art market has also bounced back after a difficult year in 2021.

However, the performance of many of these assets is idiosyncratic and may be specific to a certain artist, wine vintage or style of jewellery. Valuation can be highly subjective in sectors where assets have no objectively measurable price – they are worth what a buyer is willing to pay. The liquidity of these assets is also a serious consideration. Unless you are particularly experienced in certain markets or can afford to shrug off losses, investment in tangible objects should be undertaken with great caution.

A reputable intermediary, such as an auction house or wine buyer, can help navigate these complex markets, which are full of pitfalls for the unwary.

If you are not an expert, taking advice from someone who is qualified to do so is critical. A reputable intermediary, such as an auction house or wine buyer, can help navigate these complex markets, which are full of pitfalls for the unwary.

Precious metals

For many decades, investors have bought gold as a safe haven in which to shelter against catastrophe – in particular rampant inflation, but also the collapse of financial markets and economic meltdown. Gold proved a poor investment during the stock market boom years but returned to favour in 2019 and especially in 2020 as investors worried about the impact of the pandemic. More recently, though, the gold price has plateaued as economic recovery tentatively took hold.

The gold price also has a relationship with interest rates. Because it doesn’t pay an income, gold’s value tends to languish at times when interest rates are rising, as they are today. The emergence of crypto-currencies and their appeal to younger generations of investors may also affect the relative appeal of gold. It is possible that bitcoin or other digital assets might start to take its place as an alternative safe haven for tough economic times, although the volatility of virtual currencies in recent years has made clear they are not a one-way bet.

Other precious metals often follow the trajectory of gold, except where they have a specific and valuable industrial use. Palladium, for example, is used in electronics and chemical applications. Precious metals, too, can offer effective portfolio protection at times of international political upheavals.

Commodities have regularly provided a hedge against inflation, since demand rises as the global economy expands, which is liable to push prices higher.

Commodities and agriculture

Commodities have regularly provided a hedge against inflation, since demand rises as the global economy expands, which is liable to push prices higher. This traditional correlation may be losing some of its force – economic expansion in the 21st century has not necessarily created as much new demand for raw materials as it did 20 years ago. The market is also changing as countries start to create green infrastructure and accelerate the energy transition, entailing demand for different types of raw material, such as so-called rare earths.

Commodity prices were strong in 2021 as economic recovery ran into supply bottlenecks, as well as concern over political tension in eastern Europe. The war in Ukraine has since led to a lasting surge in commodity prices. These factors have contributed to a strong run of performance for commodities and companies involved in supplying or processing them. Investors now have a broad range of options for investment in commodities markets, including cheap and liquid exchange-traded products or specialised actively-managed funds.

Another diversification option for investors is agriculture. This has attracted wider investment interest in recent years as a sector tapping into growth of the middle class in middle-income emerging markets. As living standards improve, people tend to eat more meat, which in turn requires more grain, creating a virtuous circle for agricultural businesses.

Meanwhile, threats to global food supply, including climate change and political unrest such as military risks to exports from Russia and Ukraine, are also spurring food prices. The UN Food and Agriculture Organization estimates that agricultural production will need to increase by 70% by 2050 in order to feed the world’s forecast population of 9.7 billion people. Investing in these assets therefore raises significant moral issues that have become even more sensitive since the onset of the war in Ukraine.

From currencies to catastrophe bonds

Other types of investment reserved in the past for institutions are gradually entering the mainstream, at least for well-informed investors with an appetite to take on more risk in search of higher returns. Venture capital offers investors the opportunity to benefit from innovative and fast-growing young companies, and is encouraged by generous tax breaks in some countries.

Private equity investment has seen considerable expansion in recent years, with many large and high-profile companies remaining in private hands for far longer than they would have done just a decade ago. Meanwhile, wealthy investors are increasingly being offered access to the market via dedicated private banking products.

Increasingly, venture capital and private equity have become the channel to invest in emerging technology companies.

Increasingly, venture capital and private equity have become the channel to invest in emerging technology companies. This type of ownership gives business owners more freedom and control than they might have after a stock market listing. Investors interested in venture capital and private equity now also have a range of fund options. But investors should also remember that most innovation-focused start-ups never return any money to investors; venture capital firms look to the handful of stand-out successes to compensate for the majority of failures.

Relative value trade

Currency funds may also provide diversification away from bond and equity markets, because currencies are a relative value trade – one currency against another, or against a basket of currencies. Skilled currency managers aim to deliver positive returns under all market conditions, but this goal is very difficult to achieve and many go out of business.

Other options could include catastrophe bonds, whose returns are usually contingent on extreme weather or natural disasters such as earthquakes rather than economic disruption. Specialist lending funds have emerged over the past decade as in many countries capital constraints have prompted banks to cut back corporate lending, especially to smaller and riskier businesses.

Some or all of these investment classes could play a useful role in attaining greater portfolio stability at a time when the environment for conventional financial markets has become less predictable. It is also good investment practice to increase the diversity of your portfolio and look for ways to smooth out returns over time – as long as you remain aware of the potential pitfalls.

Finally, you should always remember that the current geopolitical tensions make any medium-term projection particularly uncertain, so it is more important than ever to seek the help of qualified experts before considering any investment in many alternative asset classes, where the watchword is caveat emptor.

It may be an opportune moment to start thinking about incorporating alternative options to diversify and, ideally, inflation-proof an investment portfolio.