Are Alternative Investments Right For Your Portfolio?

Are Alternative Investments Right For Your Portfolio?

In recent years it would be difficult to read any financial newspaper or website without seeing headlines about “alternative investments”. This term is rarely defined by media accounts but seems to encompass hedge funds, private equity, infrastructure investments, as well as real estate.

While a common definition of alternative investments continues to prove elusive it’s probably fair to say that alternative investments tend to be less regulated, less liquid, and less transparent than most stock and bond funds available to individual investors.

Private equity? Hedge funds? Sounds risky…

While these can be risky options the reality is they encompass a variety of investment strategies and risk tolerance levels.

There are private equity firms engaged in buying and turning around relatively conservative businesses, such as manufacturing consumer staples or operating refineries. Others take extraordinary risks in their pursuit of returns, like the venture capital firms in Silicon Valley.

The same holds true in the world of hedge funds; some operate balanced strategies that seek to preserve capital and earn a modest return above inflation, while others make leveraged bets on speculative stocks or in commodities markets.

Infrastructure and real estate tends to be a much less glamorous part of the alternative investment landscape, as investing in large projects like toll-roads and office buildings tends to generate slow but steady returns over years or even decades.

What are the benefits of these alternative strategies for investors?

There are a variety of potential benefits, but those most frequently cited include additional diversification, returns that aren’t necessarily connected to the health of the overall stock or bond market, and outsized returns that come from risking capital over large periods of time.

In truth there are almost countless alternative investment strategies being applied in the marketplace today, and simply conducting research and due-diligence on all of them to determine their risk and reward characteristics has become a new line of business for many full-time research professionals. 

How can I evaluate whether these make sense for me?

The recent rise of alternative investments in mutual funds available to the public has fueled interest in this area of the market previously only available to large institutional investors or high net worth individuals. Unfortunately this newfound ease of access doesn’t make these investments any less risky.

Consider a short checklist for including or excluding alternative investments as part of your portfolio:

• Am I investing for a long time horizon?
• Does my portfolio need additional diversification beyond typical stock and bond asset classes?
• Is there a chance I will need to access this money in the near term?
• Is my risk tolerance sufficient for these opaque and lightly regulated investments?
• Do I have a trusted professional helping me find the right investment options?

While there is no hard and fast rule as to how many of the above need to be a “yes” for alternative investments to fit your circumstance it is certainly fair to say these are not for the DIY investor. While hedge fund returns and private equity corporate buyouts often make headlines, the same is true for the frauds and spectacular crashes in this growing corner of the market. Before making a decision about alternative investments talk to your financial planner about what investing strategies can help you meet your goals for your financial journey while still prudently managing the investment risks along the way.