The Role of Alternative Investments in Diversifying Your Portfolio
As to the added spice that alternative investments offer to your portfolio – which new horizons and unexplored growth avenues that you might wish to deploy – consider whether these fit with your aims and risk profile for your overall portfolio.
Alternative investments offer diversifaction benefits not specific to public markets making them an integral part of a well-diversified portfolio. But how can you screen for suitable investments to add to your portfolio?
Investing in Private Markets
Today, money is flowing into private markets like never before, with greater choice of business sectors and industries than public markets, often with lower correlations to classic asset classes, such as stock and bonds.
But investable opportunity sets are at best niche offerings, often unregulated and illiquid, and, in most cases anyway, aircraft are expensive: either more costly in minimum investments or upfront fees than, say, a mutual fund or ETF, or more expensive to operate (aircraft still are aeroplanes, after all).
Given the risks involved, investors should build up exposure to private markets too slowly. Adding a new alternative exposure slowly, over the course of several years, rather than all at once, could help to mitigate risk, and help build up longer-term, more attractive ownership perspectives.
In light of this, those qualified individual clients1 who would like to discuss adding an allocation to alternative investments as part of their long-term portfolio strategy with a trusted advisor may consider it prudent to do so. 1 A qualified individual client is a client for whom the adviser has reasonable grounds by reason of either: the client’s net worth being in excess of $250,000; the client’s income exceeding $250,000 annually; or the client’s assets exceeding $1 million in value, excluding the client’s primary residence. Investor disclosure: Charles Lieberman is the founder and chair of Charles Lieberman Investment Management (www.clim.com). He has authored books on asset allocation and has served as a senior market strategist at State Street Global Markets and principal of Harcourt Findlay Group. His current positions have been taken from the firm’s managed accounts. This research does not constitute an announcement of any new investment strategy by the firm. Investors are cautioned against making unnecessary trading decisions based on changes in financial markets or the opinions expressed in this article.
Diversifying Your Portfolio
By including alternative assets and international markets in your portfolio, you can both reduce the risk that would occur due to changes and gyrations in public markets, and broaden your investment universe to capture more of the global market.
Diversifying is a widely used strategy by investors, which aims to reduce risk and enhance returns. The old saying is: ‘Don’t put all your eggs in one basket.’ Diversification is the process of investing in a wide variety of assets (said to be ‘load ball bearings’). Diversifying can protect investors from large losses and enables them to stay the course to reach their financial goals more easily.
Conventional asset classes include stocks, bonds and cash, but such investments are just the beginning: alternative investments such as private equity, hedge funds, commodities (managed futures), art, collectibles, and real estate can all provide important diversification benefits as well. Low correlations with the prices of stocks and bonds can decrease risk and improve portfolio return; most provide extended investment horizons and so are perfect additions to portfolios.
Diversifying Your Assets
Investing is a risky proposition. The more savvy among us know that simple diversification helps mitigate this risk by allocating among the different asset classes so that one’s risk is not too highly concentrated in any one area. Alternatives can be especially useful in this regard since they don’t fit into neat, discrete categories such as stocks, bonds or cash.
Because real estate and precious metals have low correlation with stock markets, for example, they could be good additions to portfolios if there are negative swings in stock prices. Other common alternative asset classes are hedge funds, managed futures and commodities, art/collectibles/collectibles and derivatives. Many believe that alternative investments are investment vehicles accessible only by Wall Street insiders, but average investors can access them as well by simply opening a self-directed IRA and utilising it by investing in alternative opportunities. Investors may benefit from even lower risk while further diversifying their investor portfolios with alternative investments, and introducing alternative investments into an investment plan could assist in mitigating systematic risks such as inflation and interest rates in one’s portfolio.
Diversifying Your Income
Moreover, peripheral streams of income are a faster path to whatever financial goals you have. Retirement nest egg? Second income. Mortgage? Second income. Your kids’ college? See the trend? Also, having more than one stream lets you do things you normally wouldn’t be able to because you are passionate about it and you have room in your budget to accommodate it. This is how you build net worth.
But unlike stocks and bonds, alternative investments serve an important function in an investment portfolio – such as diversification, volatility reduction, yield enhancement and inflation protection – but, unfortunately, they are also avoided due to the fear created by the illiquidity of the asset classes.
Now, with the right vehicle and the right partner, average investors can use their self-directed IRA to access non-correlating investments and profit from non-correlated investing strategies that can enhance their total portfolio. Investors need to understand what type of job their investments are going to perform, as part of a portfolio strategy, to select the appropriate alternative asset class for those needs.