More investors are looking at diversifying their portfolios to include
alternate asset classes.
Alternate assets combine low volatility with
stable returns that are independent of the performance of the stock
markets.
What is an alternate asset?
It is perhaps easier to explain what an alternate asset is not - it is not a stock, bond, debenture, or any instrument that has a direct claim on an entity issuing it. An alternate asset is a type of asset that is traditionally considered as part of an investment portfolio to diversify the risk on the portfolio.
Historically, it included real estate, commodities , antiques, rare coins, stamps etc. But in recent times, futures, options, private equity, venture funds, and hedge funds are also considered alternate assets in an investment portfolio. Alternate assets can bring significant benefits to investment portfolios by diversifying risk exposure away from traditional asset classes like stocks and bonds.
What is an alternate asset?
It is perhaps easier to explain what an alternate asset is not - it is not a stock, bond, debenture, or any instrument that has a direct claim on an entity issuing it. An alternate asset is a type of asset that is traditionally considered as part of an investment portfolio to diversify the risk on the portfolio.
Historically, it included real estate, commodities , antiques, rare coins, stamps etc. But in recent times, futures, options, private equity, venture funds, and hedge funds are also considered alternate assets in an investment portfolio. Alternate assets can bring significant benefits to investment portfolios by diversifying risk exposure away from traditional asset classes like stocks and bonds.
Low correlation and absolute returns
The reason alternate assets help in diversification is that they
generally do not move in the direction of the stock markets and thereby
help a portfolio sustain market volatility.
A common thread among them is their low correlation with both stocks and bonds. Low correlation is an important factor when considering assets for inclusion in a portfolio.
They reduce the portfolio's exposure to systematic risk. However, it has to be kept in mind that such a portfolio will underperform in comparison to any asset class that is having a bull run.
A common thread among them is their low correlation with both stocks and bonds. Low correlation is an important factor when considering assets for inclusion in a portfolio.
They reduce the portfolio's exposure to systematic risk. However, it has to be kept in mind that such a portfolio will underperform in comparison to any asset class that is having a bull run.
| Why low correlation?' | |||||||
One may ask the question how these assets manage to have a low
correlation. Some of these assets like rare coins or real estate have
no connection with financial assets issued by companies. Hedge funds
take long and short positions in a dozen different global futures
markets - stock and bond indices, currencies , and gold.
Hedge funds also follow strategies that help them profit from the construction of off-setting positions in equity, fixed income or other instruments, and directional positions in asset classes such as commodities, global equities and real estate.
The most common investment strategies in private equity include leveraged buyouts and buying distressed investments.
Hedge funds also follow strategies that help them profit from the construction of off-setting positions in equity, fixed income or other instruments, and directional positions in asset classes such as commodities, global equities and real estate.
The most common investment strategies in private equity include leveraged buyouts and buying distressed investments.
In a typical leveraged buyout transaction, the private equity firm buys a majority control of an existing or mature firm.
Mutual funds offer structured products with capital protection, which will have a negative correlation with the underlying stock markets in turbulent times.
Mutual funds also offer various exposures to directional alternate assets like commodities, real estate and foreign currencies.
Volatility itself is developed as an alternate asset class and offered by mutual funds with benefits of a negative correlation to equities. Hence, either due to the inherent nature of the asset or as deliberate strategy the alternate assets a have low correlation to stocks.
Mutual funds offer structured products with capital protection, which will have a negative correlation with the underlying stock markets in turbulent times.
Mutual funds also offer various exposures to directional alternate assets like commodities, real estate and foreign currencies.
Volatility itself is developed as an alternate asset class and offered by mutual funds with benefits of a negative correlation to equities. Hence, either due to the inherent nature of the asset or as deliberate strategy the alternate assets a have low correlation to stocks.
Disadvantages
But the disadvantage is that these assets are less liquid .
Investors may not be able to liquidate these investments quickly. For
example, artifacts take a long time to gain value.
They are difficult to value and suffer from subjective bias. Investments in infrastructure projects, private equity and real estate funds take a long time to fructify. Therefore, alternate assets were till now the domain of the high net worth individuals only.
Alternate asset classes of real estate and private equity are bound to grow here as the economy matures. Gradually, the economy will develop alternate mechanisms to finance growth that do not necessarily rely on equity markets alone which will give a boost to private equity, hedge funds and venture capitalists.
Alternate assets are now accessible via traditional retail products such as mutual funds and hedge funds to individual investors too. Gold exchange-traded funds (ETFs), arbitrage funds, and capital protection funds are some examples.
Combining different types of alternate assets in a portfolio can produce a more optimal asset allocation. The benefits of such investments will be visible during sustained periods of weak equity markets.
They are difficult to value and suffer from subjective bias. Investments in infrastructure projects, private equity and real estate funds take a long time to fructify. Therefore, alternate assets were till now the domain of the high net worth individuals only.
Alternate asset classes of real estate and private equity are bound to grow here as the economy matures. Gradually, the economy will develop alternate mechanisms to finance growth that do not necessarily rely on equity markets alone which will give a boost to private equity, hedge funds and venture capitalists.
Alternate assets are now accessible via traditional retail products such as mutual funds and hedge funds to individual investors too. Gold exchange-traded funds (ETFs), arbitrage funds, and capital protection funds are some examples.
Combining different types of alternate assets in a portfolio can produce a more optimal asset allocation. The benefits of such investments will be visible during sustained periods of weak equity markets.
