In building a strong investment portfolio, it is important to consider several investment options.
Diversification is a critical consideration when building a portfolio as it helps to spread risk across various assets whilst ensuring that financial goals are attainable. As a result, it is always advisable to have a balanced mix of traditional and alternative investments in any given portfolio.
Traditional investments include stocks, bonds, and cash. Any other financial asset that does not fall under the conventional investment definition is classified as an alternative investment. Examples include real estate, private equity, venture capital, infrastructure, distressed securities, hedge funds and collectibles such as artwork, antiques, vintage wines, stamps, and several others. Alternative Investments have a low correlation with traditional asset classes, making them suitable for portfolio diversification. Investments are generally long-term, close-ended, and unlisted.
Alternative investments have been around for decades but have gained significant traction in recent years. Volatile money market returns coupled with evolving attitudes towards wealth building and the emergence of an innovation culture have generated interest in alternative investment strategies. We have seen an increase in investors embracing unconventional strategies such as crowdfunding schemes, cryptocurrencies, and early-stage venture capital. Given this demand and the increasing flight for yield, the market has seen a rise in alternative investment product offerings globally.
According to a recent McKinsey & Company report, the current surge in alternative investments is only the beginning of a new wave of growth. The report states that institutional investors are exploring new paths and increasing their allocations to alternative investments. It also suggests that alternative investments are increasingly becoming mainstream.
There are a number of reasons why alternative investments are rising in relevance to investors. A few of them are:
Potential for Higher Returns
Many alternative investments offer more attractive returns than traditional investments. Given the active management involved in some alternative asset classes, as well as the long-term holding periods, there is a likelihood of generating superior returns. Also, the illiquid nature of the asset class commands a premium over traditional investments.
Diversification Benefits
Most alternative investments are high risk investments; however, they provide strong diversification benefits. Given the low correlation of returns with traditional investments, the inclusion of alternative investments in a portfolio provides great diversification potential by spreading risk across multiple assets.
Reduced exposure to volatility
Investors are exposed to reduced volatility given low correlation with traditional asset classes. This provides portfolio stability in the long-term.
Access to Unique Investment Opportunities
Alternative Investments provide investors with a variety of options that are not readily available in other asset classes. The asset class also comprises the vast majority of investable options in the marketplace. For example, broadly speaking, most unlisted, privately held businesses are potential opportunities.
Alternative investments are a great way to add diversification, variety and return enhancement to an investment portfolio. However, as with any other investment, goals and risk tolerance must be taken into consideration before funds are allocated. Such investments should be approached with prudence and sound judgement given their illiquidity, complex nature, and degree of risk. Appropriate investors with a high capital base and adequate risk tolerance can participate in the alternative investments space with advice and guidance from a financial adviser. This point was aptly made by Rodney Sullivan, the editor of the Journal of Alternative Investments and a professor at the University of Virginia Darden School of Business. According to him, alternative investments “are still perceived as a risky asset class, but the risk isn’t bad as long as that risk is diversified and offers a consistent return.” He added that the onus falls on financial advisers to ensure that they use their expertise to guide clients in the right direction.