I periodically recycle old posts on my blog to ensure that new clients can benefit from valuable content they may have missed and this post on alternative investments caters to savvy investors is one such example.
When I first started in the financial services industry in this part of the world nearly 30 years ago, alternative investments were “special” things only for “aliens”. Today, local investors are more open to new ideas such as alternatives to diversify their holdings in cash, stocks, property and operating business.
What is an alternative investment? Thanks to technology, anyone can google search the topic and will be able to find all the information that you want. The answer can be both simple and complex depending on the different types of investors.
According to Investopedia, an alternative investment is a financial asset that does not fall into one of the conventional investment categories. Conventional categories include stocks, bonds, and cash.
Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Property is also often classified as an alternative investment.
Alternative investments exhibit a low correlation with traditional equities and fixed income and as a result, they can help diversify a portfolio more effectively. However, there is still a lot of misunderstanding surrounds alternative investments like hedge funds.
Boys and girls, misconceptions can be costly. Here are some of the common myths which I have broken down here. Don’t let these myths hold you back.
Myth 1: Alternative investments are highly risky.
Reality: They are “risky” just like every other investment including equities. Based on statistical and historical perspectives, alternative investments can deliver better risk-adjustment performance over time and some of you might even think my claim here is blown out of proportion, exaggerated and fake.
Investors need to perform thorough and complete due diligence before making an allocation to alternatives. The due diligence is just the first step. Implementation and monitoring can be even more time consuming and confusing for those who are not experts in the field. It takes a massive amount of work. I know some financial advisors are woefully understaffed for this type of work related to alternatives.
Myth 2: You need a lot of money to invest in alternative investments.
Reality: For many in the wealthy class, investing in alternatives represents something of a status symbol. It certainly took many years but there are more ways to access alternative investments than ever before. There are investments which require a much lower minimum capital, as low as the thousands of the dollar range to suit different profiles of investors.
Myth 3: Alternative investments are very “expensive”.
Reality: The big problem in the last couple of years has been the underperformance of active managers who charge higher fees. Just look at the hedge funds with 2 and 20 fees structure. Nobody wants to pay high cost. I’m a cheapskate too.
It is not because something is cheaper, that it is better. Investors who want to be better aligned with their managers have to look at other considerations such as the strategy, the team, the investment structure and other differentiating factors. Fees become less relevant as long as investors enjoy solid performance after fees.
Myth 4: Alternative investments are underperforming equities and hedge funds are no longer capable of adding value.
Reality: In fairness, it needs to be pointed out that some of the alternatives have not performed up to expectations. However, to damn the whole industry is silly. I have observed that investors have become less and less patient, expecting positive performances every month from their managers.
The real alternative investments aim to deliver better risk-adjusted returns than the volatile equity market. They are not trying to beat the market benchmarks. Some types of alternative strategies tend to be more correlated to equities while others behave more independently. Investors need to understand how the pieces work together.
Myth 5: “I can make a lot of big money from alternatives overnight.”
Reality: Investors should be looking at alternative investments as a source of diversifier of a portfolio. Beware of investment scams. “There’s a sucker born every minute.” Remember the social media is always littered with shady offers.
Myth 6: Alternative investments are illiquid.
Reality: Just throwing something into a portfolio is likely going to be a bigger problem. Investors should know what they are getting into. There are both liquid and illiquid versions of investments in the alternative space. A private equity fund can lock investors up for a couple of years. There are not easy to sell. However, there are other alternative investments which provide better liquidity.
Myth 7: Larger and well-established players perform better than the smaller ones.
Reality: To make it more politely, this is not necessarily the case. Assets are the enemy of returns which means a very large asset base makes generating returns more difficult. I love to work with high calibre managers who are flying under the radar and who are very good in what they are doing and have “limited” capacity.