Alternative investments can help shield portfolios from volatility, according to an Envestnet PMC webinar, and also can provide improved liquidity and protection of capital. Those are just some of the potential advantages provided by a growing universe of alternatives, many of which provide improved liquidity.
Tim Clift, chief investment strategist at Envestnet PMC, explained that portfolios that can use leverage, engage in short selling or have access to noncorrelated opportunities offer nontraditional investment strategies not found in traditional long-only portfolios.
In addition, liquid alternative investments—which are growing in number and availability—provide advantages that traditional alternative investments did not offer to many investors, including daily liquidity, transparency, a lack of accreditation requirements, lower minimums, a reduced fee structure and efficient tax reporting.
All these advantages have resulted in what Cerulli characterizes as explosive growth, with assets in alternative mutual funds tripling between 2008 and 2011 and going from $78 billion in AUM to $214 billion.
Envestnet, said Clift, thinks that a 20%–30% allocation to alternatives in a portfolio is the optimum, because they are not risky. In fact, he said, “nothing could be farther from the truth,” since alternatives provide a number of advantages, including hedging strategies and a way to lower interest rate risk.
They can also provide a means of absolute returns, which provide a significant reduction in downside risk in exchange for surrendering a bit of upside potential.
Robert Kea, portfolio manager in the global asset allocation group at Putnam Investments, seized on the idea of absolute returns. Two very old assumptions, he said, were that markets go up and relative return products aren’t correlated. However, in the current climate, lower returns and higher volatility are and likely will continue to be common, so it is more important than ever to diversify client holdings.
Comparing traditional investing strategies to absolute returns, Kea said that the former defines success as beating the market and risk as lagging the market, while absolute return strategies define success as positive returns and risk as losing money. The difference between the two, in addition to the latter’s ability to “go anywhere” to seek returns rather than being limited as many fund managers are to specific types or amounts of investments and a risk-free benchmark, mean that those who follow the latter strategy will make out better than those who follow the traditional route.
And alternative investment products offer ways to do that, sometimes because they offer the means to engage in nontraditional strategies, such as shorting an investment instead of holding it. Traditional investments can beat the market and still lose money, while alternatives offer the opportunity to make money without benchmarking to the market. Guarding against volatility is more conducive to building wealth, Kea explained, than looking for high market returns, since a lower but steady rate of return will grow faster than a high and highly volatile rate of return that fails to build on early gains but loses them instead.
Christine Johnson, director of alternative and multi-asset strategies at DWS Investments, spoke about alternatives as the “new core”—comparing them to foreign investments 15 years ago, when they were a rarity in portfolios but now are commonplace. Such will be the fate of alternatives as well, she said.
She defined alternatives in the basic categories of equities, event driven, macro, relative value and illiquid—many of which are becoming more liquid and accessible.
Institutions are boosting their alternative investments, and she added that all investors should have an alternative component to their portfolios.