Viewpoint: Five myths about alternative investments

Alternative investments can provide an interesting opportunity for investors to diversify their portfolios, dampen the impact of market volatility and help them achieve their long-term investment objectives, even during times of market uncertainty.

Of course, along with these potential benefits come additional complexities and risks. That is why it is imperative that investors understand the various strategies available to make more-informed decisions regarding the role of alternatives in their portfolios.

Here, we demystify five common misperceptions about alternative investments.

Myth 1: Alternatives are only available to ultra-high-net-worth investors and institutions

Truth: There’s a broad selection of offerings within the alternatives universe – and they can appeal to different types of investors. While it’s true that some types of funds may restrict investment to qualified purchasers or accredited investors, other investment vehicles exist that provide access to alternatives without the same restrictions.

Indeed, offerings range from listed vehicles that provide exposure to various alternative strategies or private markets to closed-end funds, which invest in a variety of real assets – for example, real estate, new energy, and infrastructure.

However, with such a broad range of offerings in this category, it is important to thoroughly understand the specific risks and benefits of alternatives as an asset class, as well as the characteristics of the various strategies. In addition, the specifics of the available instruments should be considered before including them in a portfolio.

Myth 2: Alternatives add investment risk to your portfolio

Truth: It depends. One should note, that the risk-return characteristics of different alternative strategies vary widely. While some aim to generate higher returns, others primarily seek to reduce risk.

When looking at an alternative strategy as a standalone solution, it may have a higher risk profile than more traditional holdings because of its higher targeted returns. However, some alternative strategies may have more conservative risk profiles and commensurate lower returns yet offer exposure to non-traditional market risk factors.

Alternatives are often influenced by different market circumstances than traditional investments like stocks and bonds, and don’t always follow the same performance path. In fact, some alternative strategies, such as market-neutral are designed to lower overall portfolio risk.

These characteristics make alternatives an attractive source of diversification and return potential – and even a possible buffer against volatility.

Beyond investment risk, it’s also important for investors to be mindful of other potential risks related to the unregulated structure of many alternative investments. Reviewing your overall portfolio risk tolerance is a great place to start.

Myth 3: The illiquidity of alternatives is bad for investors

Truth: First of all, not all alternative investments are illiquid.

As mentioned earlier, investors can potentially access alternative strategies through regulated funds with regular liquidity. On the other hand, the illiquid nature of certain alternative investments can potentially be a boon to your portfolio.

For example, alternative strategies that are not in daily-liquidity vehicles are less likely to be forced to sell holdings quickly – and at a lower price – during market turmoil than traditional mutual funds, which may need to raise cash to meet daily redemptions.

Plus, even though investors may not be able to withdraw funds on a daily basis, this higher illiquidity can allow for investment in possibly higher-yielding or more complex assets.

Myth 4: Alternatives is synonymous with hedge funds and private equity funds

Truth: Alternative investing spans a wide spectrum of investment strategies. Beyond hedge funds and private equity funds, other key market segments include private credit, infrastructure and real estate. In addition, each market segment features strategies with different levels of risk, return and liquidity.

In short, alternative investments are investments that go beyond traditional long-only investments, such as stocks and bonds. Because alternatives tend to have less correlation to traditional investments, they may provide interesting opportunities for investors wanting to diversify a portfolio and provide a return profile that might differ from those of traditional investments.

For example, private credit strategies have grown in prominence since the global financial crisis, fuelled by the retrenchment of traditional lenders like banks and now encompass several sectors. Alternative credit and private strategies like this can potentially offer investors a chance to earn attractive returns over time – and get compensated for higher illiquidity and complexity risks.

Myth 5: Alternatives aren’t a necessary part of your portfolio

Truth: Especially during times of uncertainty, investors can look beyond traditional asset classes for other sources of returns in order to meet their financial objectives with greater confidence.

By adding alternatives to the mix, investors may be able to enhance portfolio performance, boost diversification and reduce their overall risk. Importantly, alternatives can help investors pursue their goals by being a source of new opportunities and expanding the investable universe.

In summary, alternative investments may offer a unique risk-return profile and complex investment characteristics that means they aren’t suitable for every investor.

However, for investors wanting to look beyond traditional investments to an expanded set of market opportunities to try to meet their diversification and return objectives, then alternatives may provide an interesting opportunity.