Alternative investments, dubbed “alts” for short, is the umbrella term for essentially everything outside of the traditional category of asset classes that are popular with the majority of investors.
Traditional investments such as stocks, bonds, and cash are accessible to the general population via public markets and are characterised by high liquidity. They can be highly sensitive to market fluctuations.
On the other hand, alternative investments are typically not publicly traded, may have lower liquidity, and could potentially be less transparent than traditional investments.
Examples of alternative investments
Some examples of alternative asset classes are real estate, private equity, private debt, natural resources such as commodities and agricultural land, and infrastructure such as airports and hospitals. The alternatives universe also includes non-traditional methods of investing, such as private equity funds, private credit and hedge funds.
As they tend to be complex and are less regulated by the financial authorities, alternative assets are often held by Professional Investors or high-net-worth individuals, as well as institutional investors.
That being said, there are also ways for individual investors to access and include alternatives in their portfolios. These include investing in a real estate fund/REITs, directly investing in a company or project (such as a property developer or an infrastructure project).
Why should investors consider some exposure to alts?
If in line with each individual's risk appetite and investment objective, adding exposure to alternatives can potentially offer further portfolio diversification and downside protection, and possibly higher returns than traditional equities and bonds.
Diversification is key to your portfolio construction, as a risk mitigation strategy. Alternative assets generally have a lower correlation to traditional asset classes. That means they typically do not move in the exact same direction as public market assets such as stocks and bonds, making alts a good addition to a portfolio as a diversifier. They can also potentially lower volatility and increase the resilience of your portfolio in the event of a market downturn depending on strategies chosen.
Based on analysis by JP Morgan Asset Management, looking at data spanning from 1989 to 2022, adding alternatives into your investment portfolio of traditional equities and bonds can enhance your risk-adjusted returns.
Furthermore, some alternative investments employ strategies that seek returns that outperform the public markets; hedge funds and private equity are examples.
Therefore, some investors who have a longer time horizon and do not need to access their cash in the short-term might find it attractive to get potentially higher risk-adjusted returns from alternatives while forgoing liquidity.
The exact weight or allocation of the alternative assets within a diversified portfolio will depend on the investor’s risk tolerance, return objectives, investment horizons, liquidity constraints, and financial goals. Remember that as with any investment, the higher the potential returns, the higher the risks you must assume.
Learn more: Understanding hedge funds
What are the risks?
Even though alternative investments provide diversification and could potentially enhance returns, they also come with more complexities and risks than traditional investments.
- Lack of liquidity
Private equity or hedge funds have lock-up periods and redemption schedules requiring investors to commit their capital for a period of time. This makes the money inaccessible for lengthy durations. Typically, the redemption schedule is monthly or quarterly.
In contrast, public equities can be liquidated at any time if you need to use the money on short notice.
- Regulation and valuation risks
Private markets, where most alternative assets reside, are characterised by their opaque nature when compared with public markets. Private companies are not obliged to reveal earnings or financial information, and are not subject to the same reporting requirements as their publicly-traded counterparts.
The lack of transparency, combined with the illiquidity and product complexity, can make it difficult to price alternative assets accurately. There may also be a greater risk of fraud given that alts are not heavily regulated.
- Use of leverage
Some alternative funds use leverage — that is, borrowed capital — to amplify returns. If successful, the investors reap larger returns. However, if the investments underperform or decline, such leveraged funds can result in bigger losses.
Endowus has a private wealth arm that can provide access to more investment products such as alternative investments, which are only available to professional investors. Contact us today for a consultation.
Click here and get started with Endowus.
Read more:
- How alternative investments can fit into one's portfolio
- How much am I meant to allocate to private credit, private equity, and hedge funds?
- Understanding hedge funds
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