Alternative investments: Means to diversify a portfolio

Alternative investments: A deep dive into the most common myths

Persistent myths surround alternative investments. That being said, this asset category likely makes sense as a portfolio complement, especially in the current environment: both as a valuable source of returns and for portfolio diversification. A closer look at the most common myths regarding alternative investments.

Alternative investments are an antidote for volatility

Low interest rates, high inflation and, last but not least, the Ukraine-Russia conflict: investors currently do not have it easy on the financial markets. This leads to the question of where to invest – given that high-quality bonds are expected to have higher volatility with lower return expectations in the future. Money market investments that can be used to park liquid assets are also barely offered anymore.

Alternative investments, such as private equity or hedge funds, therefore seem to come right on cue. Since they have a fundamentally low correlation to traditional asset classes, alternative investments are a suitable tool for further diversifying the portfolio and avoiding risk concentration. Furthermore, they may offer some protection from inflation or stock market crashes.

Traditional investments compared to alternative investments

Traditional investments compared to alternative investments

For illustrative purposes only.
Source: BlackRock 2021: What are alternative investments?

Five disproven myths about alternative investments

Although investor interest has picked up considerably over the years, there is still something mysterious about alternative investments and no shortage of myths surrounding them. The five most common myths put to the test.

Myth 1: "Alternative investments are reserved for institutional investors."

The favorable risk/return characteristics of alternative investments have long since piqued the interest of private investors. However, most of these instruments were not accessible to them in the past. That being said, the barriers to entry have been lowered considerably in recent years. Private investors can now invest smaller amounts in some fund of funds. In addition, alternative investments, such as a portfolio component of a discretionary mandate, are comparatively easily accessible.

Myth 2: "When investing in alternative investments, investors barely have access to their invested capital."

Private equity or hedge funds in particular have a much lower tradability than traditional investments and thus bind investors for a longer period. However, this illiquidity is precisely what can also offer potential added value. Flexible investors who invest part of their portfolio in less liquid investments can benefit in the form of an illiquidity premium and can be largely protected from irrational investment decisions during the holding period.

Myth 3: "Alternative forms of investment are (too) risky."

Considered separately, some alternative investment instruments do indeed have a higher risk profile than traditional investments. However, just as with traditional investments, there are strategies that are more stable and those that are riskier. This is because carefully selected alternative investments may make perfect sense as an additional element in a portfolio. Not only do they tap into additional return potential, they can also improve the risk/reward ratio of the portfolio thanks to the low correlation to traditional asset classes. The applicable principle here is: Careful selection of the available alternative investments is important in order to make the most of such diversification advantages.

Myth 4: "Alternative forms of investment are (too) expensive."

There is no question that higher investment costs are incurred with alternative investments, such as hedge funds and private equity, due to the laborious investment process. When selecting fund managers, it is therefore especially important to make sure they can justify these costs in the long term by delivering above-average net returns for their investors. Once again, careful selection is therefore a critical success factor.

Myth 5: "The alternative investment universe seems opaque and elusive."

As a matter of fact, it is often very difficult or even impossible for private investors to gain an overview in the field of alternative investments. This is due to the variety of existing strategies, instruments, and fund managers.

Fully exploiting the potential of alternative investments requires careful selection, taking into account several factors. The significance of a structured and detailed selection process of best-in-class products and their continuous monitoring should not be underestimated. The following applies: With careful evaluation and professional advice, the mass of information can be bundled into manageable sections.

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