Moving beyond traditional equities and fixed income into alternative investments has driven wide-ranging benefits for institutional investors versus their individual investor brethren, stemming from the unique characteristics and distinctive benefits alternative investments can manifest within a portfolio. A few examples of such advantages include greater portfolio diversification, the ability to hedge inflation, achieving higher return potential, and accessing new exposures and opportunities. Let’s look into these.

Diversification

Portfolio diversification is one of the most powerful benefits afforded by alternative investments. The returns and other performance metrics of alternatives typically exhibit low correlations to traditional asset classes such as stocks and bonds. Allocating to alternative investments has the potential to lessen volatility without sacrificing return, thus making them an effective risk management tool for minimizing the risk of an investment portfolio. While all investments involve some level of risk, adding diversifying investments with low or no correlation to other portfolio allocations may lower portfolio concentration, reduce volatility and achieve stronger risk-adjusted returns. It's important to note that no amount of diversification or correlation can ensure profits or prevent losses.   

Inflation hedge

Alternative investments also can serve as an effective hedge against inflation, meaning that their returns have been correlated to inflation. As inflation rises, the returns of these investments also tend to rise. As a result, the investment is considered to protect against the decreased purchasing power of a currency that results from the loss of its value due to rising prices. Put another way, the practice of inflation hedging can help protect the value of an investment. While certain investments might appear to provide a healthy return, when inflation is factored in, they can be sold at a loss. For example, investing in a stock that generates a 4% return, but with inflation at 5%, would result in a loss of buying power. Commodities and infrastructure represent examples of investments often used to hedge inflation.

Higher return opportunity

Pensions, endowments, foundations and other institutional investors also seek higher return potential from alternative investment allocations. This objective stems from the notion that certain alternative investments carry higher risk profiles on a standalone basis but can result in meaningfully higher returns as a reward for taking that risk. Venture capital investments represent an example. While seed and early stage investments can result in exposure to greater risk of investment loss, they also can handsomely compensate investors with substantially outsized returns. A range of hedge fund strategies also possesses this higher risk/higher reward profile.

Distinctive exposures and opportunities

As noted above, traditional stock and bond investing can offer investors the potential for growth and income. However, equities and fixed income allocations do not provide the accessibility to new or other distinctive exposures. That’s where alternative investments can bear very ripe fruit, enabling investment access to real estate, infrastructure, start-up businesses, and a host of other complements to traditional portfolios.

Given these and other portfolio benefits, why haven’t alternative investments been as widely used by individual investors? The answer is simple: lack of access historically.