Investing in Alternative Investments
Written by Lachlan Woods and Xinling Han
What are Alternative Investments?
Alternative Investments are defined as any financial assets which do not fall into one of the traditional asset classes of stocks, bonds and cash. Hedge Funds, Property, Infrastructure, Commodities, Private Equity and Real assets such as farmland, are the major asset classes considered within Alternative Investments.
Benefits of Investing in Alternatives
The traditional “60/40” allocation to stocks and bonds may no longer be enough to meet investors’ long-term investment objective. The Alternative Investments sector is expected to increase from $8.8 trillion in 2017 to $14 trillion by 2023, with the majority of this growth coming from superannuation funds and institutional investors (Preqin, 2018). There are a variety of factors why investors are looking to add Alternatives into their investment portfolio, with the key benefits being:
- Protect against the downside
- Provide other sources of income
- Enhance overall portfolio returns
1) Protect against the downside
Investing in Alternatives adds diversification to the overall portfolio because Alternatives tend to behave differently than traditional assets such as stocks and bonds. The diversification benefit comes from the fact that the growth of different Alternative assets is driven by very different factors, i.e. they have lower correlation (as seen in the table below). During volatile market period, portfolios with Alternatives proved to be more resilient, thus helping protect against downside risk.
2) Provide other sources of income
Alternatives may offer higher income than traditional investments, especially for income focused Alternative assets and strategies. As seen in the chart below, Alternative assets (grey bars) offer better yields than most of the traditional equities and bonds. The certainty of regulated returns (such as Infrastructure) also helps cash flow stability. Given the low interest rate environment, the higher yields from Alternatives provides investors with a stable and diversified stream of income.
3) Enhance overall portfolio returns
Alternative Investments can further enhance a portfolio’s risk-adjusted returns. The growth of Alternatives typically comes from structural trends rather than cyclical sentiments; therefore, they are less sensitive to short-term noise (lower volatility). Also, some Alternative assets are less liquid than traditional assets since they are usually more cumbersome to exchange and their markets are not as efficient. This allows opportunities for skilled fund managers to deliver excess performance as compared to the opportunities available within traditional investments. Investors also require an ‘illiquidity premium’ in order to compensate them for this additional risk. Therefore, adding Alternatives to a portfolio can improve and smooth the overall returns.
Asset Classes within Alternatives Universe
Risks of Alternative Investments
Like any other investments, there are potential risks involved with Alternatives investing. Because of the lower correlation with the broad market, some of the Alternative assets may underperform when equity market rallies, but also tend to outperform during market downturns. Alternatives are normally more complex than traditional investments, therefore they often have higher management fee. Another risk associated with Alternatives is liquidity risk. Some Alternatives are invested in illiquid investments such as private equity and property, making them difficult to exit compared to listed stocks and bonds.
Ways to Access to Alternative Investments
Alternative investments used to be difficult for average investors to get access to. However, over the years of the asset class’s development and popularity, there are now a variety of options for investors to invest into the Alternatives universe, including:
- Direct Investments
- Trusts and Managed Funds
- Fund of Funds
- Exchange Traded Funds
Ultimately, the key to investing success is to spread investments over a range of assets. It is through diverse asset allocation and maintaining a sufficiently diversified portfolio that an investor will be able to outperform over the long run.
Here at Carnbrea & Co, we place paramount importance on safeguarding our client’s portfolios. Therefore, we encourage clients to consider adding Alternative Investments to their portfolio to gain diversification and correlation benefits.
Our experienced team of advisers welcome the opportunity to discuss your particular requirements and how we may facilitate you in making the change you desire. As long-time advisors to investors in Alternative Asset Class, Carnbrea & Co has broad experience in investing in Alternative Investments and helping clients meet their wealth goals.