Hedge funds, commodities, gold, a Rembrandt. These are all examples of different kinds of investments that are being used more often in portfolios. These are the investments that fall into the "Other Assets" segment. These are the less known and understood investments. These are.... the Alternatives.
The traditional growth classes of shares and property continue to enjoy a predominant place in the hearts of most investors (even with all the proverbial heartache of the last few years). These investments tend to move up and down in cycles generally in sync (tendency to lead) with the broader economic cycles of growth-peak-contraction-trough. The growth and peak parts of the sequence is what we all love. The contraction and trough... not so much.
Its with this backdrop that alternative investments are primarily utilised. Its the search for investments that don't follow the same up and down cycle of traditional assets. Diversification is a word that is used extensively in portfolio management, the objective of which is to produce lower volatility (without lowering returns) or produce higher returns (without increasing volatility) or producing some combination of the two. This is achieved by combining assets that have low or negative correlation (when one goes up, the other goes down), which are characteristics that many of the alternative assets offered for investment have in relation to shares and property.
Another key reason for the inclusion of some alternatives in the portfolio mix is their ability to hedge against inflation. Most of us already have a liability to food, clothing and energy. These are all vital for maintaining a reasonable standard of living and we will all need to purchase large quantities of these assets in the future. The "negative" investment in these items means that when prices for food, clothes, petrol, electricity and gas increase, we incur a loss to our wealth. To protect against the likely increase in the price of these items (inflation) it can be appropriate to purchase assets to offset this liability. Buying the physical assets (a barrel of oil, kilo of sugar) is not very practical, thus the easiest way to get positive exposure to prices rises in food, energy, etc, is through a commodities index or fund. Gold, though not a liability, is another alternative asset that does tend to have good inflation-hedging characteristics.
The use of alternative assets has grown substantially over time as deregulation and technology has progressed. Australian investors, though, haven't moved as quickly as many of their global counterparts. For example, an average US-based "balanced" fund might have up to 30-40% in alternative style exposures, whereas Australian-based funds are still down around the 10-15% range. Also, some institution and portfolio managers tend to be more alternatives-inclined than others, such as university endowment funds and industry super funds.
As alternatives are essentially everything other than shares and property (and cash and bonds), the range of alternative investment possibilities is practically limitless. But with all investments, an understanding of the risks is vital, especially for less understood assets and securities. And a general catch-all-tip: if it sounds too good to be true, it probably is.
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