Alternative Investments Defined
When most people hear the word “investment,” the first thing that pops into their head is usually stocks, bonds and/or mutual funds. Although these investment options are common, they are not the only investment vehicles available to investors. Historically, alternative investments were exclusive to large institutions or the super-wealthy. Recently, more alternative investment products became available, giving individual investors access to unique opportunities that aid in diversifying portfolios.
Alternative investments are diverse and represent an accumulation of hedge funds, private equity, commodities, and managed futures.
Alternative investments have the ability to:
- Reduce risk and enhance returns
- Diversify portfolios
- Offer different return cycles than other investments vehicles
- Lower correlation (in comparison to traditional investments)
- Hedge against some portfolio exposure (reducing concentration risk)
- Lower portfolio volatility
- Profit in various economic environments.
These abilities and others are circumstantial, and depend on the range of investment opportunities in a portfolio and the investment manager’s skill, knowledge, and experience.
Enhanced Returns & Return Cycles
Opportunities, diversification, lower liquidity levels, and returns define alternative asset classes. Because alternative investments do not typically move with other parts of a portfolio, their return patterns differ. Different return patterns can result in risk reduction, improved diversification, and increased returns.
Diversification is critical when designing a portfolio, and is a driving force behind why alternative investments are becoming more popular. The proper construction of a portfolio can increase or maximize expected returns. Alternative investments can be risky by themselves, but as part of a portfolio they offer great potential for diversification limited by asset allocation.
While alternative investments do carry various benefits, there are additional considerations investors should take into account before investing. For example, when compared to traditional investments, alternative assets can have a much lower liquidity, and are sometimes difficult to value and measure their performance.
Due diligence is paramount when considering any investment. The concept of alternative investing is often misunderstood, but with proper knowledge, and professional guidance investors can consider the benefits of complementing different assets and strategies with their core investments. As always, seek professional counsel.