Why use Alternative Investments? Alt 101

Written by Maksim. Posted in Uncategorized

Why use Alternative Investments?

Alternative investments make up a good percentage of our clients’ portfolios.  We use alternative investments for a number of reasons, most of all, to reduce the overall volatility in the portfolio, and to get exposure to asset classes and strategies that are typically not employed by individuals and brokers.   Having alternative investments in 2007-2008 would of greatly soften the blow most individuals felt.  Even though people thought of asset classes such as international stocks, bonds,  commodities as “alternatives,” during the panic everything was sold off that was liquid.  Many individuals just wanted to “sell” and they did so without wanting to look at what the actual investments were.  Due to this panic selling, correlations on most asset classes went up, that in the end it almost did not matter what the money was invested in, it all got sold and went down in price.  We use alternatives that either can take advantage of such sell offs, or are not subjected to the effects of such sell offs.

How do we define Alternative Investments?

Alternatives will broadly fall within two categories.  Alternative investment strategies and alternative asset classes.

If you have worked with an investment advisor or a broker, you might have come across a few alternative investment strategies funds.  Some of these funds may be Leveraged or inverse investing funds, long/short strategies, market neutral and absolute return funds.  They can also be strategies that take advantage of convertible or merger arbitrage opportunities, managed futures funds and global macro funds that can go anywhere.

Investments that target alternative asset classes may seek to invest directly into real estate, commodities, precious metals, currencies and private equity & venture capital.

Both of these categories of alternatives have historically provided low correlation to the broad equity markets such as the Dow Jones Industrial Average and the S&P 500.   You can then go further and reduce market risk by allocating to non-traded investments.  These are investments in alternative investment strategies or asset classes that do not trade on the public markets and have less liquidity.   One of the risks that a fund manager has is redemption risk, where they do not know how or when investors will want to get their money back, potentially forcing the manager to have to sell off investments to cover the redemption request.  With investments that are non-traded, the fund managers do not have to worry about the redemption risks and are able to employ all of the money to the strategy they chose.

While it is no guarantee with any investments, we do believe that alternative investments belong on your list of investments to consider.  You can start with liquid alternative investments by using mutual funds, you can gain exposure to managers by using exchange traded funds, or you can dive deeper into the world and gain more benefits by implementing non-traded investments.  Pensions and private endowments have been using alternative investments for a large percentage of their portfolios for a long time, and very much attribute their above average returns to the alternative investments within their portfolios.

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