Categorization Confusion—The ‘Alternatives’ Problem

Private equity, emerging market bonds and REITs, to name a few, are often cited as “alternative investments,” but they are just subcategories of the primary asset classes. Private equity is equity; it’s just a non-liquid form of equity. Emerging markets debt is debt. REITs are equity, and so on.

It doesn’t help when mainstream reference sources even propagate the inaccurate. Look up “alternative investments” on Wikipedia and it says, “An alternative investment is an investment in asset classes [emphasis mine] other than stocks, bonds and cash.” Wrong!

It’s not that alternative investments represent different asset classes; alternatives such as long-short equity, managed futures or global macro are simply different ways to invest in or trade equities, debt, commodities and currencies. They have the flexibility to go long or short, they may employ leverage and they may gain exposure to these asset classes through the use of derivatives. However, at the end of the day, investors in alternative strategies have exposure to equities, debt, commodities and currencies. Those asset classes are just mixed in different proportions, with varying directional exposures, in order to expand the opportunity set and to fine-tune risk.

We frequently hear people say, “Oh, I don’t invest in alternatives,” and I don’t get that. Why would someone not want to take advantage of a larger opportunity set with the ability to manage risk much more precisely? I think it’s because of the fear of the unknown or the difficulty of explaining to clients what they are seeing on their statement.

To my client—Mom—I say, don’t get caught up in the fact that your statement indicates an investment in the Global Macro Absolute Return Alpha Opportunity Fund; you’re just invested in equities, debt, commodities and currencies. Let me worry about the rest.