Alternative Investment Strategies

According to numerous studies, the key to maintaining an effective asset allocation strategy is to maximize the use of non-correlated asset classes.  In fact, over 90% of the investment returns over decades has been proven to be a result of having an effective asset allocation strategy with non-correlated asset classes.  Alternative Investment Strategies are an alternative to stocks and bonds, as their cycles tend to not correlate with the stock or bond markets.  The problem with many alternative investments that are not traded on the stock markets or bond exchanges is pricing.  Many have high front-end costs, extraordinarily high annual fees, and expensive exit costs and illiquidity that can last over 10 years. 

Alternative investments that don’t typically trade on international exchanges, represent an aggregate of private real estate, private senior secured loans, hedge funds, private equity, managed futures, fixed indexed investments, commodities, and a growing number of other types of specialty investments like life settlement funds.  Alternative investments have become increasingly popular and talked-about in the recent past.  This is not only due to stories about billionaire fund managers and star traders, but also because of the unique characteristics and distinct benefits alternative investments can bring to a portfolio.

There are at least four primary benefits to diversifying into alternative investment strategies:

The popular belief that hedge funds and private equity funds are both extremely risky investments on a standalone basis is justified to a great extent. However, when you think about these investments in the context of a total portfolio, you will find that many types of alternative assets have great diversification potential. Their returns show low correlations to traditional asset classes like stocks and bonds and therefore adding alternative investments to a portfolio can reduce volatility and risk without sacrificing part of the return. Diversification is one of the strongest reasons why institutional investors–including pension plans, endowments, or foundations–commonly invest in alternative assets.

Some alternative asset classes are a good inflation hedge because their returns are highly correlated to inflation.

Because alternative investments are so diverse, you have plenty of opportunities to find new exposures, which are not accessible with traditional investments. As the list above reveals, there are numerous opportunities to increase a diversified exposure to asset classes that have different cycles from stocks and bonds.

Some kinds of alternative investments are very risky on a standalone basis, but investors are rewarded for this risk by higher potential returns. Like all the other above listed benefits, this only applies to some types of alternative investments.  Like those of traditional investments, returns of alternative investments vary over time depending on market conditions and economic cycles.