Alternative investments are generally defined as investments that fall outside the normal asset allocation guidelines.
The alternatives category encompasses a diverse range of investments that aim to provide different return and risk characteristics to traditional bonds and listed stocks.
The major characteristic of alternative investments that would compel an investor to include them in an investment portfolio is that they tend to be lowly correlated with traditional asset classes. The desired outcome is that sensible use of alternative investments will further optimise an investment portfolio by reducing risk for a given level of return or maximise the return for a given level of risk. The types of investments that are typically classified as alternative investments include:
- Commodities (soft and hard)
- Precious Metals
- Hedge funds (and Fund of Hedge funds)
- Infrastructure (non-listed)
- Other direct investments, such as artwork and antiques
- Private equity.
Although these investments can be more complex and expensive to manage than the traditional kind, investors use them in the expectation of earning a premium return, taking advantage of the opportunity to search among less efficiently priced assets. As a result, their inclusion can improve its return and risk characteristics.
The pioneers of alternative investing have been the endowment funds of major US universities such as Yale and Harvard, allowing them to earn significant, long-standing returns. Many Australian private investors have shown little interest in alternatives, with self-managed super funds in aggregate holding a negligible amount. In part, this reflects a lack of access to viable alternative investment managers. In contrast, institutional investors have had ready access and taken advantage of the opportunity. Australia’s Future Fund, for example, currently allocates around 30% of its $100bn portfolio to alternative investments. Recently, however access to alternative investments has become easier for the general public via managed funds and ASX-traded securities.
Due to the risks associated with many alternative investment strategies, including the lack of transparency and liquidity constraints, alternative investments should represent only a small percentage of an investment portfolio. We recommend that you have your investment professional review your current portfolio and determine if investing in alternative assets is suitable for you.