Reduce Portfolio Volatility with Alternative Investments
To combat volatility and diversify risk, investors have utilized asset allocation strategies, with the theory that some asset classes will go up, some down and others neutral. Over the long-term, this is an effective strategy, with the exception of 2008-2009 when all asset classes declined in tandem. A typical allocation would include domestic stocks and bonds, developed international stocks and bonds, and real estate. Accredited investors, pension plans and endowments have included alternative investments as an asset class. Alternative investments typically have a low correlation to traditional investments and are an effective tool to help reduce overall investment risk through additional diversification.
An alternative investment is an investment product other than the traditional investments of stocks, bonds, cash, or property. The term is a relatively loose one and includes tangible assets such as art, wine, antiques, coins, or stampsand some financial assets such as commodities, private equity, hedge funds, venture capital, and financial derivatives.
While many investors do not meet the requirements to invest in such instruments listed above, or may not wish have their capital committed to illiquid investments, mutual fund companies have introduced a number of products to the marketplace designed for the retail investor that provide liquidity, transparency, and low purchase minimums. Strategies may include equity long-short, managed futures, currencies, and bond arbitrage. Adding 10 to 20 percent of alternatives to your portfolio will reduce the correlation of your portfolio to stocks and bonds, dampening downside volatility. Investors can search for these types of investments using MorningStar categories, multialternative, market neutral, managed futures, long/short equity, and currency.