Written By: Robert English
Not all characteristics of alternative investments are widely understood by investors. Robert English from PIMCO looks to demystify five common misperceptions
Myth 1: Alternatives are only available to ultra-high-net-worth investors and institutions
Truth: There’s a broad selection of offerings within the alternatives universe – and they can appeal to different types of investors. While it’s true that some types of funds may restrict investment to qualified purchasers or accredited investors, other investment vehicles exist that provide access to alternatives without the same restrictions.
Myth 2: Alternatives add investment risk to your portfolio
Truth: It depends. When looking at an alternative strategy as a standalone solution, it will typically have a higher risk profile than more traditional holdings because of its lower liquidity and higher targeted returns. However, when viewed as part of an overall portfolio, the investment risks may seem more moderate; alternatives are often influenced by different market circumstances than traditional investments like stocks and bonds, and don’t always follow the same performance path. In fact, some alternative strategies, such as market-neutral are designed to lower overall portfolio risk. These characteristics make alternatives an attractive source of diversification and return potential – and even a possible buffer against volatility. Beyond investment risk, it’s also important for investors to be mindful of other potential risks related to the unregulated structure of many alternative investments. Reviewing your overall portfolio risk tolerance is a great place to start.
Myth 3: The illiquidity of alternatives is bad for investors
Truth: Actually, the illiquid nature of certain alternative investments can potentially be a boon to your portfolio. For example, alternative strategies that are not in daily-liquidity vehicles are less likely to be forced to sell holdings quickly – and at a lower price – than traditional mutual funds, which may need to raise cash to meet daily redemptions. Plus, even though investors may not be able to withdraw funds on a daily basis, this higher illiquidity can allow for investment in possibly higher-yielding or more complex assets.
Myth 4: Alternatives are synonymous with hedge funds and private equity funds
Truth: Alternative investing is wide-ranging and varied. For example, private credit strategies and certain real estate strategies, typically offered through a similar type of fund as private equity, have seen significant growth since the global financial crisis, when traditional lenders like banks began to change their lending practices. Alternative credit and private strategies like this can offer investors a chance to earn attractive returns over time – and get compensated for higher illiquidity and complexity risks.
Myth 5: Alternatives aren’t a necessary part of your portfolio
Truth: Especially during times of uncertainty, investors need to look beyond traditional asset classes for other sources of returns in order to meet their financial objectives with greater confidence. By adding alternatives to the mix, investors may be able to enhance portfolio performance, boost diversification and reduce their overall risk. Importantly, alternatives can help investors pursue their goals by being a source of new opportunities and expanding the investable universe.
Alternative investments and hedge funds involve a high degree of risk and can be illiquid due to restrictions on transfer and lack of a secondary trading market. They can be highly leveraged, speculative and volatile, and an investor could lose all or a substantial amount of an investment. Alternative investments may lack transparency as to share price, valuation and portfolio holdings. Complex tax structures often result in delayed tax reporting. Compared to mutual funds, private funds are subject to less regulation and often charge higher fees. Alternative investment managers typically exercise broad investment discretion and may apply similar strategies across multiple investment vehicles, resulting in less diversification. Diversification does not ensure against loss. This is neither an offer to sell nor a solicitation of an offer to buy interest in any product or strategy in any jurisdiction. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that any investment will achieve its objectives, generate profits or avoid losses.
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