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Alternative Thinking: Diversifying Beyond Traditional Asset Classes

Once a staple investment allocation, the traditional balanced portfolio of shares and bonds has had some challenges in delivering positive returns in today’s market environment.

Institutional investors, such as superannuation funds and endowments have been investing in alternatives for many years and it is a rapidly growing asset class in the global investing landscape. Individual investors are now looking to alternative asset classes to help diversify their portfolios and improve the probability of meeting their long-term objectives.

What are alternative assets?

Alternatives cover a broad range of asset types, which can include almost anything that does not fit into traditional, market-traded equity and bond securities. These include assets such as real estate, infrastructure, shares in private companies, private loans and debt, as well as alternative trading strategies, such as hedge funds and absolute return funds.

 

 

Why invest?

Each of these sub-categories can have very different risk and return drivers to each other as well as to traditional equities and bonds. By including an allocation to these asset classes, the diversification benefit can improve the expected risk-adjusted returns of the portfolio as a whole.

It is important to note that these asset classes are less liquid and more complex than traditional equities and bonds. Whilst it’s expected to generate additional returns or better risk outcomes for investors; the illiquid and private nature of many alternative assets generally suit investors with a longer investment time horizon.

We consider them appropriate for investors with a minimum investment horizon of five years and recommend a moderate portfolio allocation of 5-20% depending on the investment objectives of the portfolio.

Not all alternatives are the same

For most investors, a diversified allocation covering a wide range of alternatives can lead to better outcomes over the longer term. Illiquid or private assets mean that investment managers can take advantage of inefficiency or less transparent asset prices to generate more skill-based, idiosyncratic returns.

Conservative or more cash-flow based valuations can provide more portfolio stability and less sentiment driven ‘noise’ compared to the daily ‘mark-to-market’ price returns in equity and bond markets.

Alternative trading strategies can generate returns, even when markets are declining in value, by selling stocks ‘short’ or using other types of derivative instruments. Overall, these assets and funds can contribute to better returns, reduce volatility and build in more downside risk protection for portfolios.

The right mix and allocation of alternatives will vary, and the benefits of these asset classes also come with a different set of risks to consider which may not be suitable for all investors.

 

Source: Perpetual

The information in this article does not take into account your objectives, needs and circumstances. We recommend that you obtain investment and taxation advice specific to your investment objectives, financial situation and particular needs before making any investment decision or acting on any of the information contained in this document. Subject to law, Capstone Financial Planning nor their directors, employees or authorised representatives gives any representation or warranty as to the reliability, accuracy or completeness of the information; or accepts any responsibility for any person acting, or refraining from acting, on the basis of the information contained in this document. Principal Wealth Management Pty Ltd trading as BMO Financial Solutions ABN 53 109 336 601 is a Corporate Authorised Representative (CAR 277821) of Capstone Financial Planning Pty Ltd ABN 24 093 733 969 Australian Financial Services Licence (AFSL) No. 223135.

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