With valuations of traditional investments looking expensive as reserve banks force interest rates lower, alternative investments can offer investors reasonable returns that perform differently than traditional assets.
Alternative investment strategies can vary greatly and are often complex and difficult to access which is why some investors overlook adding alternative investments into their investment portfolios.
Traditional asset classes are broken up into two classes, Growth and Defensive. Growth assets include equities, property & infrastructure, and defensive assets such as bonds and cash. Alternative assets include those investment strategies considered to provide an alternative source of risk and/or return.
Alternatives, as an asset class, encompass a broad range of strategies, each of which can play a very different role in a multi-asset portfolio. In simplest terms, alternatives can be described as strategies that have underlying drivers of returns (and risk) that differ from traditional asset classes such as equities and bonds.
A primary benefit of using alternatives strategies is that they tend to have a lower correlation with the ‘traditional’ asset classes (although this varies widely across strategies) which makes them useful diversifiers in a portfolio. With traditional diversifiers such as fixed interest facing extremely low yields, alternative assets can play an increasingly important role in constructing portfolios.
Australian research company Lonsec, experts in investment research, classify alternatives under three broad categories;
Return Boosters – These strategies provide access to return drivers (or risk premium) that are not available in traditional asset classes. Private equity, private debt, private real estate or private infrastructure fall into this category. They can be moderate to highly correlated to existing exposures within the portfolio, however their higher return expectations warrant their inclusion.
Diversifiers – These strategies are expected to be lowly correlated to traditional asset classes over a full cycle. They provide a diversified source of return (and risk) to the portfolio and help smooth overall portfolio returns. Liquid hedge funds such as global macro, market neutral equities, alternative risk premia strategies fall into this category.
Risk Mitigators – These strategies tend to be negatively correlated to equity markets in time of stress and are considered ‘risk-off’ diversifiers. Given the bulk of risk in most multi-asset portfolios can be attributed to the equities allocation, such assets that increase in value as equity markets sell off as a form of portfolio insurance. Assets typically included as risk mitigators include; gold, FX currency, duration, trend following strategies. Inflation is another important risk to the portfolio that may require additional protection. Assets that may provide inflation protection include inflation-linked bonds and commodities.
The above information only gives a brief summary of the different types and characteristics of alternative assets. How they are used and the reasons why can differ greatly, but depending on your financial situation they may be considered as an important part of a well-diversified and risk balanced portfolio.
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This document contains general advice. It does not take account of your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision. Q4 Wealth Management Pty Ltd, ABN 18 634 775 830, is an Authorised Representative of Hunter Green Pty Ltd, ABN 12 087 491 629 AFSL No. 225 962.