Here’s how alternative investments can enhance portfolio resilience:
Portfolio Diversification: Diversification is the key component of alternative investments’ contribution to portfolio resilience. Equities and bonds, two common asset classes, may show a high correlation or a propensity to move in lockstep. However, alternative investments cover a wide range of assets, including commodities, infrastructure, real estate, private equity, and hedge funds, which can have lower correlations with traditional assets. This lack of correlation means that when traditional assets experience declines, alternative investments might remain relatively stable or even perform well. By diversifying across these different asset classes, investors can effectively spread risk, reducing the impact of a significant downturn in any area.
Potential for Higher Returns: While alternative investments can introduce higher risks, they also bring the potential for enhanced risk-adjusted returns. By incorporating assets with different risk profiles, investors can optimize their portfolio’s performance in various market conditions. For instance, private equity and venture capital offer exposure to companies in their growth stages, aiming for higher returns over the long term. While these investments carry inherent risks, their potential for substantial gains can improve the overall risk-return trade-off of a well-diversified portfolio.
Low Correlation to Traditional Asset Classes: Alternative investments frequently have little correlation with traditional asset classes, which means that the same variables that affect stocks and bonds have less of an impact on their performance. This low correlation can provide stability and downside protection during market volatility, as alternative investments may perform well when traditional assets are struggling.
Access to Unique Opportunities: Alternative investments grant investors access to specialized markets, strategies, and industries often inaccessible through traditional avenues. This access broadens the investment universe and offers unique opportunities for returns. For instance, investing in renewable energy projects through infrastructure funds allows investors to benefit from the growing demand for sustainable solutions while diversifying their portfolios.
Risk Management: Alternative investments can be used as a technique for risk management to protect a portfolio against certain dangers. For instance, investing in commodities or real estate can serve as a hedge against inflation. By incorporating alternative investments with different risk profiles, investors can create a more resilient portfolio that can withstand various market conditions. It’s important to note that investing in alternative investments requires careful evaluation and due diligence. Investors should assess the qualifications and track record of the fund manager or investment firm before making any investing decisions. Because alternative investments may have higher costs and more restrictive liquidity than traditional investments, investors should consider their investment horizon and risk tolerance.To assess the success of companies in managing alternative investments, we can look at their Alternative Assets Under Management (AUM) metrics.
Hedging Against Inflation: Due to inflation, traditional investments like cash and bonds may lose some of their purchase value. Commodities, infrastructure, and real estate are alternative investments that have historically proven effective inflation hedges. These assets tend to appreciate during inflationary periods, providing investors with a means to preserve their wealth and counter the negative effects of rising prices.
Tailored Risk Exposure: Investors can fine-tune their risk exposure by selecting alternative investments with risk profiles that align with their individual risk tolerances and investment goals. This customization adds a layer of resilience to the portfolio, allowing investors to construct a balanced mix of assets that match their unique financial situation and objectives.
Potential for Alpha Generation: Certain alternative investments, such as hedge funds, actively managed strategies, and private equity, have skilled managers aiming to generate alpha or excess returns beyond a benchmark. These strategies provide an opportunity to enhance portfolio returns and reduce overall risk through professional asset allocation and investment selection.
In conclusion, including alternative investments in a portfolio is a critical tool for enhancing resilience in the face of market uncertainties and economic challenges.
Their ability to diversify risk, provide stability during market volatility, and offer enhanced risk-adjusted returns makes them an essential component of a well-structured investment strategy.
However, it’s important to acknowledge that alternative investments have complexities and risks, such as limited liquidity and higher fees.
Effective due diligence, a clear understanding of each investment’s characteristics, and alignment with an investor’s risk tolerance and long-term goals are key to unlocking the full benefits of alternative investments in building a resilient portfolio.
(Author: Aditya Kanoria, Founder and MD, Credent Global Finance)