Portfolio Discussions: Alternative Strategies
Alternatives have long been part of institutional investment portfolios, with the aim of adding diversification, dampening volatility and enhancing returns. Recent industry developments now mean that retail investors can access more of these strategies. This could prove helpful in a world where experts expect lower returns and higher correlations among traditional asset classes.
Alternatives can help improve a portfolio's risk/return profile
- Adding a diversified sleeve of alternative investments, including hedge funds, private equity and direct real estate, to a traditional portfolio has led to better returns with less volatility over the past 25 years, as these assets tend to be less correlated to traditional investments.
- Manager selection is key when it comes to alternatives, as the variation in returns across this space is much wider than for core equity and fixed income strategies.
Adding hedge fund exposure can provide diversification benefits
- Hedge funds in general tend to be less volatile than large cap U.S. equities. Furthermore, hedge funds have captured less of the upside, but also less of the downside, compared to the overall stock market during the past 15 years.
- As investors prepare for a rising interest rate environment, they may want to consider some alternative investments, such as hedge funds, which can provide steadier returns with less interest rate risk.
Private investments can help to enhance returns
- Private debt and equity markets are large and complex, but the right investments can enhance a portfolio’s overall return. For example, the U.S. has relatively mature capital markets, but firms in Europe have historically relied on bank lending to obtain capital, and regulations put in place since the financial crisis could lead to growth in non-bank lending.
- Historically, private equity has outperformed public equity markets, but investor capital is often locked up for a certain period of time. However, companies are now staying private longer, and commanding higher valuations when they do choose to go public.
- Adding alternatives to an already diversified portfolio can improve its overall risk/return profile.
- Some alternatives, such as hedge funds, can help reduce overall portfolio volatility.
- Other alternatives, such as private equity and debt, can help enhance a portfolio's overall return.
Focusing on different asset classes or regions, Portfolio Discussions help to frame investment conversations using slides from the Guide to the Markets.
Bonds are subject to interest rate risks. Bond prices generally fall when interest rates rise. Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations.
Past performance does not guarantee future results. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably.
Investments in emerging markets can be more volatile.
Diversification does not guarantee investment returns and does not eliminate the risk of loss.