When we think of making an investment, most of us tend to invest in traditional investments such as stocks, bonds or related funds. However, nowadays, many pension funds, foundations, endowments and high-net worth individual are in fact allocate their money to alternative investments in proportions comparable to those given to traditional assets. To name one that you are familiar with – Hong Kong Jockey Club, has increased its alternative investments since 2013 and now the asset class accounts for over 90% of its long-term investments. Surprise?
There is no standard definition of alternative investments or definitive list of alternative assets. Examples of alternative investments include investments with any of the following characteristics:
- Investments in asset classes other than equities and bonds, such as commodities, infrastructure, real estate, land, master limited partnership (MLPs) and natural resources;
- Investments in illiquid or privately traded assets such as private equity, intellectual property, venture capital, distressed securities and private credit;
- Investments that engage in “shorting” and derivatives, such as hedge fund, market neutral and long/short equity, structured products and managed futures
Characteristics of Alternative Investment
- Potential of return enhancement – alternative investments have the potential to generate attractive long-term returns as most of them are investing in non-traditional assets (such as venture capital, art and natural resources) with a much different profit opportunities and cash flow pattern than stocks and bonds. Furthermore, some of the alternative strategies, such as market neutral and long/short equity are using “shorting” strategies, meaning that they have the potential to generate positive return during both rising and falling market environments. Besides, as some of the alternative investments require specialised expertise, knowledges as well as specific investment channels (e.g., distressed assets and intellectual property) that are not available to ordinary investors, therefore there could be more mispricing opportunities for the alternative strategies.
- Diversification – as mentioned, alternative investments invests in assets, such as real estate, commodities and infrastructure, which normally have low correlation to traditional stocks and bonds, and their prices/valuation could be driving by their own factors. As such, adding alternative investment in the portfolio should help reduce overall portfolio volatility, while historical data show that alternative investment has a much lower maximum drawdown than equities. In addition, some alternative investments such as leveraged loans can benefit from rising interest rate environment, while some of them like commodities may help to preserve purchasing power as inflation happens.
Figure 1. 10-years correlation analysis of different assets
Sources: Aberdeen Standard Investment; Noble Apex/iFund
Figure 2. Standard Deviation (%) and Maximum Drawdown of different investments
Source: Invesco; Noble Apex/iFund
- Another source to provide current income – last but not least, alternative investments such as real estate income funds, MLPs and infrastructure funds have the potential to offer a more attractive current income than bonds amid the current low interest rate environment.
However, alternative investments have some drawbacks that investors should not missed too, such as relative illiquidity, high due diligence costs as well as the difficulty of performance evaluation. Nevertheless, adding alternative investments in the overall portfolio sounds good to investors as it should help enhancing investors return and offer diversification benefits over the long-term.