Understanding Alternative Investments

Alternative investment strategies seek to generate returns independent of market movements, or alpha, and preserve capital in up and down markets. They exhibit lower correlation, which makes them a good diversifier and a complementary investment within portfolios dominated by investments in traditional asset classes. Asset growth among alternative strategies has been powerful as assets have tripled to $9.5 trillion over the past decade and they’re expected to grow to $14 trillion by 2023. Alternative investments are designed to make portfolios more efficient by enhancing return, minimizing risk or both. They’re perhaps best utilized as a complement to rather than as a substitute for traditional investments.

The key to reducing risk in a portfolio is to own investments that have low correlations with one another, meaning that they will perform differently in different market environments. Institutional investors favor alternative investments due to their potential for better risk-adjusted returns relative to more liquid strategies. Hedge funds have historically provided downside protection and generated alpha in negative environments. When the market gets too frothy, irrational exuberance among investors can lead to an overbought condition. Oftentimes, that’s followed by a meaningful correction in the stock market that can erode accumulated wealth. In that scenario, hedge funds are expected to cushion the blow on the way down.

Alternative investments have some advantages over traditional investments in that they have more tools at their disposal. They can use leverage, derivatives and short selling. They also have fewer redemption periods, which protects investors from sudden market moves but also limits liquidity. Private equity firms are known to take a more active approach to investing than their traditional counterparts and can create unique features, such as board seats at a private company. While these private equity active management strategies are expected to enhance returns, they add to the risk of investment loss.

The dearth of IPOs since the listing peak in 1996 has reduced the rate of new businesses entering the public market such that the average public company is 50% older and roughly four times larger than it was 20 years ago. Over the same period, the number of companies in the S&P 500 growing at 20% or greater has halved.

The most attractive feature of private equity is its return enhancement potential. From 1999-2018 private equity achieved a return of approximately 5% greater than large cap public equities. Private equity investors should expect to be compensated for the additional risks and illiquidity with excess returns, given the characteristics of PE investments: a long time horizon, illiquidity and a return profile that is commonly called the J-curve effect—negative in the early years and growing increasingly positive in the middle to late years.

Alternative investments play a key role in portfolios during all stages of market cycles and especially during periods of volatility. An alternative strategy has a number of tools available to hedge and protect a portfolio. Alternative investments can provide unique benefits that enhance portfolio construction to improve risk-adjusted returns. By developing a thorough understanding of the role alternative investment strategies play in a portfolio, including the rewards and risks, investors can better utilize these strategies to construct robust portfolios. The OAM Alternatives team strives to educate investors on how to allocate to alternatives while maintaining appropriate investment expectations.

Private investment pools that offer investors greater flexibility than traditional investments with the goal of hedging potential market volatility. Defining characteristics include the ability to benefit from declining stock prices through short positions, the ability to use leverage, as well as access to global markets and derivatives. These features provide investors the potential to generate positive returns in both up and down markets.

Equity strategies that make majority and minority investments in companies that aren’t listed on a public exchange. Invested capital is provided by limited partners and put to work by general partners to acquire businesses for control, fund new projects, solidify a company’s balance sheet, restructure the business model and management or fund acquisitions. They are typically less liquid with investments lasting years.

Private debt covers the lending of money to companies and individuals by entities other than banks.

Physical assets with an intrinsic worth due to their substance and properties—like precious metals and commodities.

Tangible property made up of land and anything on it, including buildings, plants, animals and natural resources. As an investment, real estate seeks income and capital appreciation.

If you're a client and want to learn more about Alternative Investments, contact your Financial Professional.

Not a client and want to learn more? Reach out to an Oppenheimer Financial Professional.

Alternative investments are riskier than traditional investments and not appropriate for all investors. Investors must bear the risk of complete investment loss and indefinite investment time horizons, as their ability to redeem may be limited by market conditions or the terms of the investment.