While so-called “alternative investments” come in many shapes and forms, they share one common element: They can serve as a portfolio diversifier, helping to offset the volatility of equities.
Prolonged stock market volatility has caused many investors to question how much of their portfolios should be allocated to equities. The world of investing isn’t solely about stocks and bonds. There are alternative investments, many of which are available only to certain qualified high net worth and ultra high net worth investors, that may provide ways to diversify1 your portfolio and potentially maximize your portfolio’s risk-adjusted return.
Alternative investments can help protect purchasing power, acting as a hedge against inflation. Additionally, they tend to have very low correlations with stocks and bonds. However, it’s just as important to understand that alternative investments are not for everyone as they are often speculative, involve a high degree of risk, and you can lose a substantial amount or all of your investment.
Alternative investments take many forms. Here is a look at several common investment types…
These investments include metals such as gold or silver, oil and agricultural products. The advantage of commodities is that they exhibit a low correlation to both equities and bonds. Consequently, when the stock market is experiencing weakness, commodities tend to hold their own. However, commodity prices are volatile, thus there is more risk. In the case of gold or silver, there are dealers who trade these precious metals. If you take physical possession of gold or silver, you will need to arrange for storage and insurance. Because many investors do not want to make these arrangements, investment vehicles such as exchange-traded funds (ETFs) are one way to access commodities.
The term hedge fund is a catch-all phrase describing funds that often follow aggressive investment strategies such as intensive use of derivatives, selling short and proprietary computerized trading. Hedge funds typically are engineered to seek a more favorable risk-adjusted return than their investors might obtain from an investment vehicle that follows a standard market benchmark. By law, hedge funds are restricted to a low and limited number of accredited investors and are primarily organized as limited partnerships. As a result, the vast majority of hedge funds target institutions and wealthy individuals
Major categories of private equity include venture capital, leveraged buyouts, managed buyouts and mezzanine financing. Investors participate in private markets through collective vehicles such as partnerships that actively manage the investment assets on the investors’ behalf. Once a particular partnership has reached its target size, the partnership is closed to new investors, including new funds from existing investors. Private equity firms frequently require investors to make commitments ranging from $5 million to $10 million or more. Successful investing in this area requires the ability to assess complex financial structures, assume outsized risk in pursuit of superior reward and tolerate extended periods of illiquidity.
Real estate investment trusts (REITs) And Real Estate
REITs invest in groups of professionally managed properties such as office buildings, apartments, warehouses or hotels. To qualify as a REIT, a company:
• Must invest at least 75% of its total assets in real estate,
• Must derive at least 75% of gross income from rents or mortgage interest, and
• Must pay at least 90% of its taxable income in the form of shareholder dividends.
REITs trade on major exchanges and can be bought or sold as you would trade a stock.
Another option is to invest directly in real estate, which allows you to gain total control over your investment. Decisions on leasing terms, amount to charge for rent, expenses to incur and selling price are all at your discretion. All investing involves risk, including loss of principal; and alternative investments by themselves can be highly volatile. But when used in combination with stocks or other assets, they may help to smooth out long-term returns and provide an alternative when stock returns are choppy.
Which alternative investments may best complement a portfolio will depend on a number of factors, including one’s existing holdings, financial situation and appetite for risk.
SAME FOOTNOTE VERBIAGE BELOW AS ALWAYS