The fundamental character of a true alternative asset or strategy, is that it will have low or negative correlation to results from the traditional asset class of fixed interest, equities or property, Tony Gillett, certified financial planner at Retirewell says.
“This means in performance terms, alternatives can act as a stabiliser or enhancer to overall portfolio returns,” Gillett tells Professional Planner.
Gillett divides alternatives into two sub-categories – alternative assets or alternative strategies.
“Then within each of those sub-categories, we divide into defensive (three-year standard deviation below five), and growth (three-year standard deviation into the five to 10 range),” Gillett says.
“We will rarely use an alternative investment with a standard deviation over 10, it’s too volatile.”
Gillett says the alternative manager should be reducing overall portfolio volatility and enhancing overall portfolio returns over time.
“If the alternative manager you know is doing their jobs properly, the inclusion of alternatives will work in any environment, irrespective of what is happening in traditional markets,” Gillett says.
But Compound Freedom certified financial planner Helen Nan says no investment is perfect.
Whether it’s a real estate opportunity, cryptocurrencies, collectibles or commodities, it’s important to consider the potential drawbacks and assess their suitability on individual circumstances, she adds.
Real estate for example, provides potential for rental income, appreciation and a sense of control being a physical asset. However, it also presents pressure in high interest environments and illiquidity.
Cryptocurrencies offer diversification potential and high growth opportunities, but there’s a lack if intrinsic value, high volatility and potential for significant portfolio swings.
Collectibles provide non-financial enjoyment and potential for value appreciation, but there can be extra costs associated with maintenance, storage and insurance, and uncertain market demand.
Commodities such as gold can hedge against inflation and have low correlation with traditional assets, but there’s a lack of income generation, storage and insurance costs.
Nan says close attention should also be given to managing risk and ensuring diversification across asses classes.
“It’s important to note that alternative investments often come with higher risks, and may not be suitable for all investors,” Nan says.
“Factors such as liquidity needs, the ability to generate income, risk tolerance, time horizon and overall investment objectives should be considered when including alternatives in a portfolio.”
Dalton Financial Partners chose private equity as its main exposure to alternatives. However, certified financial planner Joshua Dalton says the firm chose to liquidate its position in private equity this year.
“When fear exists in the economy, it can create opportunities in listed markets as certain sectors are sold off,” Dalton says.
“Then you can buy these investments at a discount. You don’t get these ‘sell off’ opportunities in private equity.”
Private equity investments are also less transparent than publicly listed investments.
“We don’t always know the full impact that a large adjustment in interest rates might have on the underlying business,” he says.
“Also, private equity has poor liquidity and investments can become frozen if things go bad, with redemptions currently taking more than three months to settle.”
Meanwhile, Shadforth Financial Group puts high value on the liquidity of investments and managing portfolios to reflect clients’ cashflow needs and risk comfort levels.
“We construct portfolios to ensure clients don’t need to sell down assets to meet cashflow just because the market is down,” Shadforth Financial Group principal private wealth adviser Joshua Blythe.
“Alternatives are certainly valid investments to consider, but investors need to understand what they are investing in and how it fits in with their overall portfolio risk profile.
