One of the most difficult jobs which most investors have to face is how to move on and make diversification of portfolios beyond the traditional asset classes. This is done for their mitigation of risks as well as for business propositions with higher returns. Equities alone performed pretty well, with high losses during the global financial crisis, pointing out to an unbalance in approach. In this regard, Australians, in particular, have been rather slow in adopting alternative investments, hence losing out on gains and stability.
It is in the United States that large institutional investors, such as the Harvard endowment fund, have managed to prove the value of alternative assets. They have run a hefty portion of their portfolio through these assets and have shown time and again the ability to make returns much better than those of the traditional market benchmarks. At the same time, Australia’s Future Fund has gone in for the strategic approach by adopting alternative investments, which delivered some impressive results and stay ahead of the targets.
Embracing alternative investments by Australians can give it a much-needed diversification and growth potential. Investors will be able to understand and embrace the likes of private equity, venture capital, and infrastructure to make their portfolio more useful and manage their risk better. How these investments are done is explained in this guide, and new innovators can get ahead in them to pursue a more solid future in finance.
Understanding Alternative Investments
What Are Alternative Investments?
Alternative investment is a class of assets composed of everything that is not under the sun of classical investments in the form of stocks, bonds, and cash. They actually stand for a really big variety of investment possibilities, which include:
- Hedge Funds: Professional vehicles designed to achieve high returns through a range of methods including the trading of currency, stocks, businesses, commodities, and bonds.
- Venture Capital: Taking a stake in the early life of what is perceived to be a high growth potential firm to commercialize a good idea.
- Water Rights, Agriculture, and Timber: In what are all dubbed the best agriculture and natural resource investments in the world.
- Unlisted Property: Real estate investments in projects such as residential developments, office towers, and industrial estates.
Why Does It Matter?
- Diversification Benefits: Alternative investments are able to invest across a lot of different markets because they typically have low correlations with the traditional classes, which means that they may perform well while stocks and bonds don’t.
- Better Returns: These investments can be judged by historical data and compare superiorly with traditional instruments. The 12% return on the Harvard endowment’s 20-year portfolio compares that return with traditional benchmarks of 9.1%.
- Inflation Hedge: Inflation hedges are on real estate and other kinds of commodities. These tend to be a natural hedge, as their price is compounded with each rise in their value.
- Access to Unique Opportunities: Alternatives often provide access to unique opportunities and investments not available in conventional markets, such as private companies or niche markets.
History of Success
Case Study: Harvard Endowment Fund
The Harvard endowment fund, a prominent example of successful alternative investing, allocates 58% of its portfolio to alternative asset classes. Over 20 years, this strategy has resulted in an average annual return of 12%, far surpassing traditional market returns. The fund’s ability to identify and manage high-performing alternative investments has been key to its success.
Australian Context: The Future Fund
Australia’s Commonwealth Future Fund, stocked at $100 billion in AUM, has also discovered the potential value that could be added by allocating to alternative investments. The Fund has been allocating 35% of its portfolio into alternatives and has done well so far in posting investment performance that is above the target, thus creating good returns. It also shows the strategic approach of increasing awareness in Australia.
Challenges and Considerations
Active and Passive Management
What’s more, this makes alternative investment an actively managed one in the sense that it continuously examines and acts as an investment vehicle for making decisions instead of something more passively managed, like an index fund, which appears to have a slightly different inherent goal—mimicking market performance. Although active management in alternatives could possibly yield a higher level of returns, it becomes highly risky and complex.
Finding the Right Manager
Indeed, a significant proportion of successful investment in alternatives is proper execution by the manager. Indeed, alternative investment managers, unlike their conventional fund manager peers, are well incentivized to perform due to solely sharing in the profits that the alternatives generate. In this sense, they have much an aligned interest with those of their investors. But, especially in the Australian market where those alternative skillfully able managers are difficult to find, the challenge can be great.
Higher Risk and Complexity
Alternative investments may be more complex and involve a relatively higher level of risk than the customary investments. They typically involve illiquidity, longer capital commitment, and higher fee parameters. Investors in these strategies need to appreciate fully these specific risks and exercise due diligence in structuring a particular program prior to investment.
Ways to Invest in Alternative Investments
Current Portfolio Assessment
Analyze your actual investment portfolio aiming to spot areas where alternative investments could provide more diversification and higher returns. Consider what percentage of the overall allocation from your assets is currently in traditional investments, and how the alternatives could fill or improve the void in your overall strategy.
Professional Advice
Alternative investments are quite complicated, so it is ideal to seek counsel from financial advisors or investment experts. They will help pick a choice from among the many options available, in choosing the manager one wants to work with, and in advising what percentage allocation it should be working around according to the type of financial objectives one desires to achieve out of a certain amount of risk it is exposed to.
A Gradual Approach
If you are new to alternatives, start small and allocate more slowly as you get more comfortable and experienced with the investments. That way, you can get a bit of experience and feel what it is like to have alternative investments in your portfolio without taking on too much additional risk.
Monitor the performance of your alternative investments and how they are affecting your portfolio throughout the year. Be cognizant of the trends and shifts in terms of investment strategies, so proper decisions regarding tweaks and changes can be made.
Conclusion
Alternative investments hold great potential gains most especially in the area related to the diversification of the portfolio, through higher returns and gain from exclusive strong opportunities. Even if they are convoluted and integrated in the aspect of risk, they still present a very firm deal in building a balanced action. With ample space for such vehicle maneuverability and the selection of careful managers, you can channel the power of alternatives to optimize the success that will portend your future financially. Accept alternative investment as part of the whole-set strategy to get a more resilient and prospering investment portfolio.
