The traditional approach to investing in public markets involves, directly or indirectly, taking an ownership position in a publicly traded company or serving as a lender to a corporate or governmental entity. Equity investors retain an ownership interest in companies that issue stock, while fixed income investors lend money to bond issuers. Investors who employ a traditional approach seek income in the form of interest or dividend payments and capital appreciation as the value of their investments hopefully increase over time.
An alternative approach to investing involves the implementation of strategies utilizing asset classes other than traditional stocks and bonds and/or utilizing an approach other than simply purchasing a security with the expectation of income and/or an increase in value. The benefit investors hope to derive by investing in such alternative investments is diversification and portfolio wide risk reduction.
Examples of “Alternative” Investments
An investment can be thought of as “alternative” based on either the assets held or the strategy implemented. Examples of alternative investments based on the assets held include commodities and real estate. Commodity investments include agricultural products, energy, precious metals, and industrial metals. Real estate investments may be direct in nature (e.g. the direct purchase of a commercial property) or indirect via a real estate investment trust. Examples of alternative investments based on a non-traditional strategic approach include hedge funds and private equity. Hedge funds may pursue a wide variety of strategies and tactics including holding both long and short positions, managing futures contracts, utilizing a top-down global macro analytical approach, pursuing specific event driven opportunities such as a corporate merger or a combination of these strategies. Private equity investors seek profits during all stages of a company’s life cycle via venture capital, buyout, and restructuring investments. Private equity investments are characterized by a general partner who takes an active role in managing a business with the goal of increasing revenue and/or cutting costs. In short, alternative investments tend to be more complicated and influenced by additional factors other than merely the movement of the stock or bond market.
Are Alternative Investments only Available to Institutions and High Net Worth Individuals?
Historically, many alternative investments were only made available to institutions and high net worth individuals. To a large extent, this is still true today. The direct purchase of commercial real estate, for example, requires substantial resources and, given the illiquidity of commercial property, a commitment to and risk tolerance for a significant holding period. Hedge funds and private equity investments are often only available to accredited investors, or individuals who have demonstrated a significant net worth and/or income. A high minimum required investment and an extended lock up period further limits the appeal of alternatives to many investors. In recent years so-called “liquid” alternatives have emerged, offering strategies similar to those offered by hedge funds but with typically daily liquidity and lower required minimum investments. Many liquid alternatives are typically available in the form of a mutual fund and are thus accessible to a wide range of investors. Because they are a mutual fund they are regulated by the federal government though that does not guarantee investment success; it does however provide a measure of regulatory oversight.
Should You Consider Alternative Investments?
It may be appropriate to allocate a portion of your investment portfolio to alternative investments as a complement to core equity and fixed income holdings. Alternative investments may serve as an effective diversifier because they traditionally have lower correlations with traditional asset classes. Therefore, allocating a portion of a portfolio to alternative investments has the potential to lower overall volatility and create smoother returns for your portfolio.
More widely available than ever, alternative investments may be an appropriate addition to your portfolio. Please contact your financial counselor to learn more about these investment instruments and how they may fit into your financial plan or contact us here.
This blog is authored by Timothy Pinch, Principal at GW & Wade, LLC with the assistance of Capital Market Consultants, Inc. (CMC), an independent investment management consulting firm. Analysis provided within this blog is the opinion of the author. Data used to prepare this report provided by CMC are derived from a variety of sources believed to be reliable including well established information and data software providers and governmental sources. CMC is not affiliated with any of these sources.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
Clients of the firm who have specific questions should contact the GW & Wade Counselor with whom they regularly work. All other inquiries, including any inquiry concerning a potential advisory relationship with GW & Wade, should be directed to:
Laurie Wexler Gerber, Client Development Manager GW & Wade, LLC T. 781-239-1188