Alternative Investments: Hedging Risks And Diversifying Portfolios

Alternative investments are financial assets that fall outside traditional investment categories such as stocks, bonds, or cash. They include private equity, hedge funds, commodities, and collectibles. These types of investments can be important for diversifying your portfolio and protecting against volatility. They can also provide access to markets that are not available through traditional investments. However, alternative investments typically have a higher risk profile and may not be suitable for all investors. They also often come with higher fees and expenses.

Lower volatility

Defensive alternative investment strategies can help to lower volatility and drawdowns compared to traditional assets. They can also help to mitigate downside risk in different market environments.

Alternative investments can include private equity or venture capital, hedge funds, real property, commodities, and tangible assets. These types of investments can act as a hedge against inflation and provide a more stable cash flow. For example, gold is considered a stable investment because it is used in a variety of industries and is seen as a store of value.

Alternative investments can also provide access to markets that are not available through traditional investments. This can make it more difficult to sell the investment, but it can also enhance price stability as there is less opportunity to panic sell.

Additionally, alternative investments can have lower transaction costs compared to traditional investments due to lower levels of turnover.

Enhanced diversification

Alternative investments can be an important part of your portfolio, helping to diversify your assets and protect against volatility. They can complement your traditional investments in stocks and bonds, and in doing so, reduce your overall portfolio risk.

Alternative investments include a wide range of assets, such as real estate, commodities, private equity, hedge funds, and tangible assets. These investments are generally less liquid than traditional investments, but they can offer more diversification and higher returns.

One of the key benefits of alternative investments is their low correlation to traditional investments. This means that alternative investments can help to maintain their value in a market downturn, as they are considered riskier. For example, hard assets such as gold, oil, and real estate effectively hedge against inflation, which is why many large institutions, such as pension funds, invest in these alternative vehicles.

Additionally, alternative investments can provide access to markets that are not available through traditional investments. This not only gives investors more specialty investment options but also makes it more difficult to sell these investments, which can be beneficial as it enhances price stability and reduces the opportunity for panic selling.

By including alternative investments as a core part of your portfolio, you can increase your chances of achieving your investment goals by tapping into a broader range of opportunities and strategies.

Increased return potential

Alternative investments can increase return potential by exposing investors to a broader range of securities. These investments can include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts.

One of the most common types of alternative investments is hedge funds. Hedge funds can engage in a wide range of investments and trading strategies not available to traditional asset managers, such as equity long/short strategies and derivative instruments. They can also provide a buffer for market downturns and assist with capital preservation.

Another type of alternative investment is private equity, which can capitalize on periods of rapid growth or restructuring by investing in private and certain public companies. Private equity managers can also improve the operations of the companies they invest in, creating even more value for investors.

Additionally, alternative investments can include real assets such as precious metals, commodities, real estate, infrastructure, agricultural land, and natural resources. These investments can act as additional diversification from stocks and bonds and can serve as a hedge against inflation.

By incorporating alternative investments into their portfolios, investors can tap into a broader range of opportunities and strategies, increasing their chances of achieving their investment goals and enhancing their return potential.

Protection against inflation

Inflation is a persistent increase in the price of goods and services in an economy over time. It erodes the purchasing power of money, reducing the value of investments and returns. Therefore, investors may turn to alternative investments that can keep up with or outpace inflation.

Real Estate

Real estate is a traditional hedge against inflation as it has tremendous intrinsic value as a tangible asset with limited supply. As inflation rises, so do property values and rental prices, resulting in higher rental income for landlords over time. Private real estate investments, such as direct ownership or private real estate funds, offer higher returns and added benefits of diversification and lower correlation to traditional asset classes.

Private Infrastructure

Private infrastructure investments, such as renewable energy projects, toll roads, and airports, provide stable and long-term cash flows that are often linked to inflation. These assets have long lifespans, providing a steady income source that is less susceptible to short-term market volatility.

Private Debt

Private debt funds invest in a range of debt instruments, including senior secured loans, mezzanine debt, and distressed debt. They offer higher yields than traditional fixed-income investments and provide a steady income stream that is less sensitive to inflation. Private debt funds also offer diversification benefits by investing in multiple industries and geographies.

Commodities

Commodities, such as semi-precious metals like copper, and futures contracts, are resources that are typically consumed and have cyclical behaviour. The value of commodities like copper is expected to increase significantly over the next two decades, making them a good hedge against inflation.

Impact-focused Private Investments

Impact-focused private investments, such as sustainable agriculture, affordable housing, and renewable energy projects, are linked to essential goods and services that are less vulnerable to inflation. These investments also have the added benefit of positively impacting society and the environment.

Gold and Precious Metals

Gold and precious metals have maintained their relative value and purchasing power throughout history. They are easily traded in liquid markets and are durable and malleable. As the value of a currency decreases due to inflation, gold and precious metals can preserve their purchasing power.

Cryptocurrencies

Cryptocurrencies like Bitcoin can be a viable hedge against inflation as they are seen as a hedge against the weakening of the US dollar.

Treasury Inflation-Protected Securities (TIPS)

TIPS are US Treasury bonds designed to protect investors from high inflation. They periodically adjust the principal amount based on the inflation rate to preserve the bond's purchasing power.

High-Yield Savings Accounts

High-yield savings accounts offer significantly higher interest rates than traditional savings accounts, helping to offset the effects of inflation.

Stock Market

Historically, the stock market has delivered returns that beat inflation. While inflation can negatively impact stock prices, investing in a diversified portfolio of stocks, including domestic and international stocks, can help protect against inflation.

Diversification

A diversified portfolio that includes various asset classes, such as stocks, bonds, commodities, and real estate, can help reduce the impact of inflation on investment returns.

60/40 Stock/Bond Portfolio

A 60/40 stock/bond portfolio is a traditional mix of stocks and bonds that can help hedge against inflation. While it may underperform compared to an all-equity portfolio over the long term, it provides a safer and more conservative investment strategy.

Mutual Funds and ETFs

Mutual funds and exchange-traded funds (ETFs) provide easy access to a diverse portfolio of stocks and can help protect against inflation.

Certificates of Deposit (CDs)

CDs offer higher interest rates than traditional savings accounts and can provide some protection against inflation, especially if the interest rate is higher than the inflation rate.

Senior Secured Bank Loans

Buying senior secured bank loans can provide higher yields while protecting against a price drop if interest rates rise.

Inflation-Linked Bonds

Inflation-linked bonds, such as TIPS, adjust their principal value based on the inflation rate, helping to preserve the purchasing power of the investment.

Alternative Investment Platforms

Alternative investment platforms offer access to a range of alternative investments, such as real estate, gold, and cryptocurrencies, providing investors with more options to hedge against inflation.

Access to new markets

Alternative investments can provide access to new markets that are not available through traditional investments. These can include private equity, venture capital, hedge funds, real estate, commodities, and derivatives contracts.

For example, investors can access private equity by buying shares in private companies or start-ups, which is not typically done through traditional investments. Similarly, venture capital provides an opportunity to invest in private companies or start-ups, offering a refined approach to stock investments.

Hedge funds, another form of alternative investment, are also usually only available to accredited investors with high net worth and substantial investment capital. These funds can employ various investment strategies, such as equity long/short strategies and derivative instruments, that differ from those used by traditional asset managers.

Real estate, as an alternative investment, can involve investing in physical properties, property-based securities, real estate crowdfunding platforms, or real estate investment trusts (REITs).

Commodities, such as gold, silver, oil, or agricultural products, offer yet another avenue to access new markets. These tangible goods have real-world uses and often benefit from perpetual demand due to their underlying characteristics.

By providing access to these diverse markets, alternative investments offer investors opportunities to explore different sectors, reduce their reliance on traditional stocks and bonds, and potentially enhance their portfolio's overall performance.

Frequently asked questions