When most people think of investing it’s either property, shares, bonds or cash that come to mind, but there are other types of investments known as “Alternatives”. They are typically the domain of large institutions, which according to a 2012 Russell Investment Survey 22.4% of institutional portfolios are allocated to Alternatives. Not surprisingly, Alternatives are popular with high net worth investors as access has tended to be fairly exclusive.
So what are Alternatives?
Alternatives typically include hedge funds (they can make money trading markets regardless of whether they are going up or down), private equity (ownership of private businesses) and real assets that can include commodities, private real estate, infrastructure and more.
How are they different?
Alternatives have been favored in volatile times because their expected returns are generally not aligned (correlated) to the traditional asset classes of equities, bonds and cash. This can provide good protection in a portfolio if equities or bonds fall in value.
The returns are attractive, it is typical for a private equity manager to target returns to investors of 20% or more per annum. As at 31 March 2015, Cambridge Associates, a firm that tracks the performance of private equity in the US, puts the average return from private equity at 13.45% per annum over the last 20 years. This is higher than the US S&P 500 (9.79%) or the ASX 200 that returned about 9.5% per annum over the same period as per the 2015 Russell Investments ASX Long Term Investing report.
How to invest?
There are a number of things to consider when investing in Alternatives, these include:
- Manager – investing is mostly via a specialist manager, a specific expertise is required and some managers are better than others. A good track record is essential as it demonstrates a proven approach.
- Liquidity – with private equity, funds are tied up for a long period of time, typically for at least 3-5 years. It’s not like the stock market where you can sell at any time.
- Fees – the fees are higher given the specialist nature of investing in alternatives and higher return expectations, managers generally make the most out of performance fees so at least their interests are aligned with achieving results.
- Underlying investments – looking for strong industry fundamentals, opportunities for cash generation, a clear exit strategy and general fit within a given risk appetite are just a few considerations.
Alternative investments present unique opportunities and will continue to grow in popularity as more investors look for returns outside the equity and bond market. As a result, they certainly have a role to play in any diversified portfolio.
Happy investing.
Rob Gilmour is the Managing Principal of Wealth Simplicity. The information provided should not be considered personal financial advice as it is intended to provide general advice only. The content has been prepared without taking into account your personal objectives, financial situations or needs. You should seek personal financial advice before making any financial or investment decisions.