A question we get quite often is, what are Alternative Investments and should they be in your portfolio?
In the past Alternative Investments were reserved for institutions. Now, they’ve become a popular asset class among many investors. In this short series, we’ll focus on Alternatives and go through why they’ve gained so much attention recently. But more importantly, the risks of not following an appropriate due diligence process before jumping in.
We’ve recently shared our views on “the death of bonds.” In other words, we’re not expecting traditional bonds to be a good source of returns in the next decade.
The current rates are extremely low -even negative, in some countries- and this isn’t likely to change very soon.
The low-interest rates have created a challenging environment, especially for pension funds and retirees. Top institutional managers turn to Alternative Investments as a partial replacement for their Fixed Income strategies.
For example, take a look at la Caisse de dépôt or the Canada Pension Plan. Both have reduced Fixed Income and increased Alternatives quite dramatically: 38% in one case and over 40% in another.
So, what exactly are Alternative Investments?
In general, they are financial assets not publicly traded on the market. They can be as varied as private companies, private debt, private real estate, or some special strategies.
Just like with bonds and equities, the Alternative asset class itself doesn’t provide the benefits. It’s how each product is selected and allocated in the portfolio that makes the difference.
There are many aspects a Portfolio Manager must assess when it comes to putting together an Alternative basket. Here are just a few ones:
- The quality of the strategy. How sustainable is the manager’s investment process, and how does it hold up in different environments.
- The consistency of the performance, month over month, and year over year.
- The correlation between the different alternatives to reduce the overall volatility.
- The level of liquidity. We need to understand how quickly you have access to your money.
- The level of visibility. It’s important to evaluate the underlying holdings of the investments
- The actual corporate structure to ensure investors’ interests are well protected, and to understand the tax and legal implications.
As you see, each position requires an extensive research process. And once we build the alternative basket, it must be allocated strategically in the portfolio to act as a counterbalance with the other asset classes.
The Key Takeaway?
The traditional portfolio composed solely of equity and fixed income is no longer the preferred option to meet most investors’ expectations. Alternative Investments are an excellent option, as long as proper due diligence is done and follows a rigorous selection process.
We’ll explore how we evaluate alternatives in our next video.
On behalf of the TWM Group, thanks, and see you next time.