Alternative Investments May Contribute to More Efficient Portfolio Construction
Improvements in liquidity and transparency are making Alternative Investments increasingly accessible for retail investors.
Where’s the Smart Money Going?
Because of uncertain bond yields, extreme central bank intervention, and uncertainty in the stock markets, the most sophisticated investors in the world are allocating more of their assets to Alternative Investments.
They believe that Alternative Investments will give them a better chance of achieving sufficiently high returns to meet future cashflow obligations while protecting against excessive downside.
Source: Canadian Pension Plan Investment Bureau, 2021What are Alternative Investments?
Generally speaking, Alternative Investments are any asset class that is not among the three traditional asset types (stocks, bonds and cash) and are used, among other objectives, to more fully diversify a portfolio.
| Alternative Assets | Other Alt Investments | Alternative Strategies |
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The Goal of Alternative Investments
Alternative Investments permit more efficient portfolio construction with the potential to deliver on a range of desired outcomes:
- Portfolio diversification
- New sources of income
- Enhanced returns
- Volatility & drawdown management
- Interest rate risk management
- Inflation risk management
Diversifying with alternative asset classes may help smooth out the volatile returns of public market investments
This stylized diagram is for illustrative purposes only, and does not reflect suggested performance of any type.
Market Factors Driving Interest in Alternatives
Several factors are driving interest for Alternative Investments among sophisticated investors:
- Higher correlations between traditional asset classes, exposing a portfolio to greater risk in a drawdown.
- Uncertain interest rates. Yields remain historically low and income is harder to come by.
- Creeping portfolio risk. As investors have sought to replace income in their portfolios due to falling government bond yields, substitutions have included longer duration bonds, high yield bonds, dividend paying equities, and preferred shares – all which may increase portfolio risk.
- Uncertainty concerning the market cycle.
Monthly Rolling Correlation of S&P 500 vs 10-Year US Government Bonds
Source: Morningstar and St. Louis Fed (FRED), September 2022
Common Risks and Offsets for Retail Investors
While the definition of Alternative Investments has broadened, “Alts” still suffer from the perception of being high-stakes, high-torque hedge funds.
Today’s hedge funds are more focused on risk management, while the broader set of Alternative Investments to which they belong are designed to provide stability to a portfolio through better diversification.
That said, for retail investors interested in Alternative Investments, there are some important considerations:
- Access: In the past, investing in Alternatives required significant investment minimums. Today, a range of funds are available to give retail investors exposure to Alternative asset classes, with varying degrees of risk that a financial advisor can best assess.
- Liquidity: Some Alternative Investments,such as Private Debt and Private Equity, are best-suited to investors who can support an allocation of less-liquid investments in their portfolios. That said, investors may want to explore Liquid Alts which provide many of the benefits of Alternatives, but offer daily liquidity.
- Transparency: Many Alternative Investments are privately traded, so there is limited information available on pricing, track records, and comparability (benchmarks). Good manager selection can help here, as can the visibility offered by Liquid Alt products.
In all cases, please consult the applicable product offering documents for full disclosure of risk factors.
| Alternative Investments | Accredited Investors | Mutual Funds | ETFs |
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| Private Debt |
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The role Alternative Investments can play in a portfolio
When well managed, Alternatives have the potential to complement core equity and fixed income allocations by improving diversification, managing risk, providing income, and enhancing returns.
A professional asset allocator can help determine if Alternative Investments will help a portfolio achieve its investment goals.
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