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06 Apr 21
What is meant by alternative investments?
Alternative investments seem to be everywhere at the moment, but what are they? Mark O'Neill, FPFS, Chartered Financial Planner and Director at True Bearing, explains more about this type of investment.
Put simply, alternative investments don’t slot into the traditional categories of bonds, equities or cash. Generally, their prices have low correlation to the main three categories and whilst they can invest in traditional asset classes, they can also adopt arbitrage or short selling to take advantage of price differentials.
Common examples are; Private equity, Venture capital, Private debt, Hedge funds, Real estate and Commodities where direct investment has traditionally been only for higher net worth or institutional investors. However, many retail funds have for years now allowed retail investors the opportunity to access these underlying holdings via a collective to diversify their portfolios.
For individual investors, this broad universe may also include; cryptocurrencies, wine collections, vintage cars or even works of art (if not a Banksy that eats itself!). All of which are assets individually unregulated by the FCA.
Alternative investments can be complex and present unique risks, so it is vital that investors understand the strategies used and obtain qualified advice to make well-informed decisions. For instance, many “alternatives” can be illiquid and we have seen several high profile examples of restricted access to client funds documented in the press of late. Tangible assets can also be subject the whims and fashions of collectors and require additional costs to store, insure and protect.
How can alternative assets be used to manage risk in a portfolio?
Alternative investments can be used to provide investors with diversification in their portfolios, cushion the impact of market volatility and help them achieve their long-term investment goals. Crucially, such diversification can be useful in uncertain times such as the current Covid pandemic for the right investor.
As alternatives have lower correlations to traditional investments, they can offer return profiles that can vary from standard asset classes.
How can alternative assets contribute to portfolio returns?
By introducing additional layers of diversification to reduce portfolio risk and potentially enhance return, as many types of alternative asset classes aren't correlated with stocks and are expected to perform best when equity returns are flat or even negative.
Subject to risk profile, while alternatives may form only a small percentage of investors’ overall portfolios, the right investment strategies can have a significant impact on returns in the right market conditions.
Their market independence can help to bolster a portfolio and introduce positive performing assets so that it fares well even through an economic downturn.
And let’s not forget, very occasionally it’s more about losing less than taking risks to make more!