The alternative investment universe isn't as mysterious as it once was. There are now roughly 10,000 hedge funds with $2 trillion in assets, and financial advisors increasingly are becoming aware of alternative investments and plan to use them to reduce risk and enhance client portfolio returns, according to Rydex Investments.

Findings from a recent Rydex AdvisorBenchmarketing survey showed that 64% of advisors planned to increase the use of alternatives, citing their absolute returns and access to non-correlated assets as the two drivers of client demand.

At the same time, a separate Rydex survey of 500 mutual fund investors found the great majority are still largely unaware of alternatives and their potential benefits. After being given a description of alternative investments, however, 60% said they would consider investing in alternatives.

At a panel discussion this week in New York on the topic of alternative investments, executives at Rockville, Md.-based Rydex Investments stated the case that such investments are becoming more broadly accepted across the financial spectrum. Morningstar and Lipper, for example, recently introduced separate categories that track mutual funds with different types of alternative investments.

Alternatives can appeal to retail investors because they potentially offer low correlation to stocks and bonds with the goal of producing so-called absolute returns over time regardless of how stocks or bonds perform, said David Reilly, director of portfolio strategies at Rydex, which manages about $15 billion in assets via 100 mutual funds and exchanged-traded products.

"While the industry has done a good job focusing on diversification," Reilly said, "it hasn't done a good job focusing on correlation, partly because these investments haven't been available to retail investors. They've been the domain primarily of institutions and high net worth investors."

Individual investors have been shut out due mainly to high minimum requirements, lack of liquidity and other barriers, he said. Retail investor portfolios have tended to consist primarily of traditional assets-domestic and international stocks, bonds and cash-but individual investors are starting to have easier access to alternatives through hedge funds and exchange-traded funds (ETFs).

Rydex recently introduced the Rydex Alternative Strategies Allocation Fund aimed at retail investors. The fund invests in a suite of alternative mutual funds and ETFs, including other Rydex funds, to provide exposure to alternative asset classes and investment strategies such as absolute returns, commodities, managed futures and real estate. The fund uses a quantitative approach to evaluate underlying assets, and also incorporates a currency arbitrage strategy that tries to take advantage of currencies with the lowest yields and reinvest those assets into currencies with the highest yields.

P.J. DiNuzzo, president and chief executive of DiNuzzo Investment Advisors in Pittsburgh, said his firm became an early adopter of alternative investments for its clients, who are mainly retirees with 401(k) and 403(b) lump sum distributions, as well as small- to mid-sized pension funds. "We were forced to construct portfolios, which included alternative investments, to reduce risk in our clients' portfolios a full decade before the rest of the country because of our location and being in a market where the median age is much older than in other parts of the country," DiNuzzo said.

Alternatives currently comprise about one-third of the firm's average client portfolio, and DiNuzzo said he was pleased with overall returns to date this year. "We're only down about a one-third ratio of the S&P's decline with our 65% to 35% asset allocation" since the market peaked on Oct. 9, 2007, he said.

-Bruce W. Fraser