Alternative investments can include a range of options outside of more traditional approaches such as long-only stocks and bonds. The simplest way to think about alternative assets is to split them into two categories: private and real assets, and liquid alternative strategies.
Private and real assets
Alternative assets are a broad category of investments outside traditional stocks and bonds, and they’re typically unavailable to retail investors due to their lack of liquidity and their level of complexity. They can be broadly sorted into two groups: private assets such as private equity and private credit; and real assets, which are physical assets with intrinsic worth, such as real estate, land, infrastructure and commodities. The latter provide exposure to the real economy, such as roads and bridges, power lines, apple orchards, corn fields and office towers. From an investment standpoint, investors are attracted to private and real assets thanks to their low correlation with traditional asset classes like equities and bonds, their ability to protect against inflation (since their revenues are often tied to CPI), and their higher yields than traditional fixed income products. Moreover, since real assets typically provide critical products and services, they bring an element of stability to traditional portfolios.
“Liquid alternative” strategies
In Canada, regulatory changes have given retail investors better access to a class of strategies often called “liquid alternatives”. These strategies generally hold traditional investments such as stocks and bonds, but grant the fund manager greater flexibility than traditional strategies in terms how they can manage that portfolio. Rather than simply buying and selling (as in a conventional long-only strategy), liquid alternative strategies have greater flexibility to employ shorting and leverage than traditional funds. This can provide more diverse sources of returns for investors, while also providing the liquidity that retail investors need.
Examples of alternative assets
- Real estate – commercial buildings, apartment blocks, office space
- Timber and agriculture – farmland, forestry
- Infrastructure – toll roads, bridges, airports
- Commodities – gold, crude oil
- Currencies – United States dollar, Pound sterling, Euro, Japanese yen etc.
- Private credit – lends money directly to small and medium-sized businesses that may be unable to issue bonds
- Private equity – Ownership stakes in private companies
Examples of liquid alternative strategies
- Long/short equity – able to profit from stock price gains in its long positions and stock price declines in short positions
- Managed futures – trades a portfolio of futures, options and swaps contracts
What do alternative assets mean for investors?
Although each strategy and underlying asset itself is different, in general, alternative assets and strategies have low correlations with traditional asset classes. Adding them to an existing portfolio can therefore often improve the risk/reward dynamic of a portfolio.
Given their long list of positive attributes, you might wonder why more investors don’t have greater exposure to alternative assets. The fact is, for years, institutional investors such as public and private pension plans, as well as many high net worth investors, have enjoyed the benefits of alternatives. However, regulations, high costs, illiquidity and complexity mean that retail investors have traditionally been excluded from investing in alternatives directly.
Traditional funds can offer some exposure to parts of the real economy by holding securities issued by firms in the infrastructure, agriculture and real estate sectors, but since their holdings are traded on public exchanges, they’re still exposed to public market shocks. This has resulted in retail investors missing out on the key benefits that many alternatives can offer.
Traditional barriers to entry for accessing alternative assets
- Minimum investments – can be in the millions of dollars
- Access – individual retail investors can’t easily access most alternative opportunities due to regulations
- Transparency – it can be difficult to get a clear view of underlying holdings
- Liquidity – it can take years to redeem capital
- Complexity of investing – capital calls process can be complicated and can take years to get client funds invested
As mentioned above, regulatory changes have made many liquid alternative funds available to all retail investors in Canada, however most investment that fall under the real of private or real assets remain out of reach for the typical retail investor.
Fitting alternatives into an existing portfolio
Extending the benefits of alternatives to retail investors through liquid alternative funds is beneficial, it’s important to remember that these remain highly sophisticated and complex investment vehicles. As a result, they will not be suitable for everyone and investors should think carefully and discuss their financial goals, investment timeline and risk appetite with their advisor before investing.
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