THE term “alternative assets” conjures up an image of the counterculture—tie-dye shirts and magic mushrooms. But in financial jargon it means those assets that are not equities, bonds or cash. It covers everything from hedge funds to property, infrastructure projects to art.

When the stockmarket was rising by 20% a year in the late 1990s, interest in alternatives was limited. Equities provided all the excitement that investors needed. But in recent years a combination of poor stockmarkets and low bond yields have made alternatives fashionable.

Since 1995 global pension funds have increased their portfolio allocation to alternatives from 5% to 19%. In just the past two years there has been a 15% increase in the assets managed by alternatives managers on behalf of insurance companies, according to a new survey by Towers Watson, a consultancy. The 100 biggest alternatives managers look after more tan $3 trillion of assets.

This diversification makes some sense. If the various alternative-asset categories share one characteristic, it is illiquidity. Over the long run you would expect illiquid assets to deliver a premium return (over the risk-free rate) to compensate investors for not being able to get immediate access to their money. Institutional investors, such as pension funds and endowments, can afford to take the long view and wait for these illiquid assets to come good.

But the drive into alternative assets also runs counter to a long-running decline in fees. Institutional investors have used their buying power to persuade traditional fund managers to lower their fees.

Many institutions have also switched parts of their portfolios into index-tracking funds, where the expenses may be only a few hundredths of a percentage point. Alternative-asset managers’ fees tend to be a lot higher. Big institutions can negotiate better terms—they may not have to pay the famous two-and-twenty combination of annual and performance fees charged by hedge funds and private-equity firms. But they are still giving back some of the hard-won cost gains of previous years.

An even bigger question is what drives the returns on alternative assets. In the case of property, which accounts for around a third of the total that institutions allocate to these assets, the label “alternative” is a misnomer. Property has been around for centuries. But it does afford genuine diversification. Property offers an income stream, in the form of rents, and a long-term hedge against inflation.

For the other alternative-asset classes the issue is whether they represent a different income stream from mainstream assets, and whether they are liquid enough to absorb lots of capital. Infrastructure projects offer the potential for inflation-linked income (from road tolls, for example), although they are subject to regulatory risk. But institutions are keener to invest in projects that are up and running than to finance greenfield schemes.

Whether private equity offers a superior return to the conventional stockmarket, once you allow for the risks involved in using high levels of debt, is a controversial subject. Clearly, however, if economic conditions are poor, private-equity portfolios are just as likely to suffer as publicly quoted companies.

The hedge-fund industry is diverse. It ranges from the giant macro funds that make bets on the back of their economic analysis to “long-short” equity funds that pick stocks and “managed futures” funds that try to ride the market’s short- and long-term trends.

Some managers offer institutions exposure to the same risks they face elsewhere (to quoted equities, say). In contrast, a hedge fund that bets on volatility might do well when the stockmarket falls. But the expected return from this approach may be close to zero. There is no reason why the manager should consistently anticipate changes in volatility, and there is no underlying return from the strategy, in the sense that equities pay dividends or bonds pay interest.

It seems highly likely that adding alternative assets to an institutional portfolio can provide investors with a smoother return. That does not necessarily mean, however, that they will deliver a higher return. It is, of course, theoretically possible to transform a low-risk portfolio into a high-return portfolio through leverage, the use of borrowed money. But many institutional investors (pension funds are a notable example) cannot really take advantage of this possibility. So the idea that alternative assets will solve the pension-funding crisis is simply misguided.