Why have alternatives in a portfolio?
Alternative investments – such as real estate, private equity, infrastructure and commodities are no longer the preserve of the most sophisticated investors. Adding a variety of alternatives to a traditional portfolio has the potential to enhance returns while also reducing risk because they don't typically move in lockstep with other parts of a portfolio. Alternatives are the modern-day "diversifiers"— and they are more accessible than ever through ETFs.
While definitions of alternative investment funds vary, they generally represent assets that move independently of domestic stock and bond markets. Alternatives typically exhibit lower levels of liquidity than traditional financial assets like stocks, and higher levels of volatility.
Although some alternative investments can exhibit higher volatility, their low correlations to traditional asset classes can give alternatives the potential to enhance a diversified portfolio’s risk/return profile. Today, alternatives can generally be accepted as essential components of broadly diversified portfolios.
Portfolio applications for alternatives
A strategic allocation to one or more alternative investment funds can help insulate a portfolio during downward moves in equity and bond markets to help enhance the portfolio's risk/return profile over time.
Investors may also choose to tactically allocate toward certain alternative assets based on their macroeconomic views. The benefits of ETFs are particularly valuable in the alternatives space, which has historically been marked by low levels of transparency and liquidity, and high costs. Using alternatives in a portfolio may deliver:
- Improved diversification (i.e. non-, low or moderate correlation) when added to a traditional portfolio consisting of stocks and bonds
- The opportunity for enhanced returns when added to a traditional portfolio
- May decrease risk of the overall portfolio