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Sometimes the smallest piece of the pie can be the most vexing.

Most financial advisers limit the so-called alternative assets portion of their clients' asset allocation to 5% to 10%. That's barely a sliver compared with the 50%, 60% or even 70% investors might direct toward stocks or bonds, depending on age and risk tolerance.

Even so, financial advisers say the alternative investments allocation often receives a disproportionate amount of attention from their clients, mostly because it lumps together complex and potentially volatile asset classes such as real estate and commodities. Furthermore, alternative investments' lack of correlation with the stock and bond markets often frustrates impetuous investors who are looking to chase performance.

During the late 1990s, for example, Marjorie Fox, a financial adviser at Virginia-based Rembert D'Orazio & Fox, says many of her clients pleaded with her to shift money from underperforming alternative asset categories into red-hot large-cap growth stocks. She says they were ultimately thankful when she dissuaded them from doing so.

"Nobody wanted diversification during the bubble, but owning real estate funds and commodities through the bear markets have helped even out returns," says Fox. "Nowadays I warn my new clients in advance that there will be years ahead when you wish you did not own alternative assets."

This year, however, is definitely not one of those years. While the equity markets mostly have moved sideways, the average REIT fund is up 21% year to date, according to Morningstar -- marking the fourth year in a row of outsized REIT returns. And analysts such as Lipper's Don Cassidy expect the trend to continue for a fifth year as long as the economy continues on its current slow-growth trajectory.

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"The public is still acting in response to their injuries from the bear market," says Cassidy. "They can relate to real estate better than they could technology during the bubble, because they can see and understand real estate. And the dividends don't hurt either."

Most financial advisers take into account their clients' homes and second homes when determining the final percentage allocated to real estate stocks or funds. If a client already has a large stake in a commercial property, then the adviser might drop the allocation entirely.

Real estate funds comprise various types of REIT shares, including apartment, hotel and office properties. Although REITs are considered equity investments, many investors view REITs as a substitute for bonds because of their yield. The average 12-month yield on a REIT fund lately is 3.3%, according to Morningstar.

Nevertheless, when a sharp rise in interest rates drives down bond prices, analysts say, REITs are often unfairly taken along for the ride. For example, earlier this year the Cohen & Steers Realty Index, a major REIT tracking index, fell close to 20% after a pair of blowout employment reports sent the yield on the benchmark 10-year Treasury bond from less than 4% in late March to more than 4.75% in early May. Only after the

Federal Reserve

made it crystal clear it would not be aggressive in raising rates did REITs bounce back from their spring beating.

"Even though we have had a phenomenal run-up in real estate funds, there is a strong need to have it in the portfolio just for diversification," says Diane Pearson, a financial adviser at Pennsylvania-based Legend Financial Advisors. Pearson says she allocates 7% to 10% of her clients' assets in real estate funds such as the

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Cohen & Steers Realty Shares fund.

Real estate has not been the only alternative asset in vogue this year. Commodities -- which include oil, gold, timber and coal -- have also been hot, as evidenced by the impressive returns of the two most popular commodity funds, the

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PIMCO Commodity Real Return Strategy fund and the


Oppenheimer Real Asset fund, which are up 16.9% and 29%, respectively.

Both are front-end loaded funds that offer direct exposure to commodity prices, and both have been rocketing upward as the price of a barrel of oil has risen from the low $30s in January to the high $40 range today. What separates the pair is their choice of indices to follow, as well as the type of fixed-income securities the portfolio managers hold as collateral to back up their derivative or commodity futures bets.

The Pimco fund's strategy is to use a small amount of derivatives to mimic the performance of the Dow Jones-AIG Commodity Index, which tracks not only oil but precious metals and other non-energy commodities as well. The Dow Jones Index is capped at 33% when it comes to petroleum exposure, and that limits the fund's instability in the face of major crude price swings.

Fund manager John Brynjolfsson breaks it down even further. He says crude oil currently accounts for 18% of the movement in the portfolio, gasoline 5% and heating oil 5%.

The Oppenheimer fund, on the other hand, uses the Goldman Sachs Commodity Index, which also covers commodities other than energy. However, 60% of the fund's performance is linked to the price of oil -- that makes it more concentrated, and therefore a more volatile fund.

Since the Pimco fund gains full exposure to the index with only a fraction of the assets, because of the derivative leverage, the rest of the fund is mostly composed of TIPS, or Treasury inflation-protected securities. Managing fixed-income securities is, of course, a Pimco specialty. That is why Brynjolfsson uses his bond portfolio not only to recoup the expenses of running the fund, but also to beat his bogey.

Kevin Baum, portfolio manager for the Oppenheimer fund, tries a different tactic, backing up his commodities futures contracts with low-duration, high-quality fixed-income securities, thus eliminating most interest rate and credit risk from the portfolio.

Before chasing the rally in commodities, however, Lipper analyst Andrew Clark says investors should remember that this is still a very volatile sector.

"Unsophisticated investors should watch their commodity exposure very closely," says Clark. "We are late in the market move, which can be a dangerous trap for some people."