Given today’s investment landscape, a new way of thinking is needed. Portfolio construction based on traditional asset allocation has not provided the diversification needed to navigate challenging markets. As a result, investors are seeking other means to diversify their portfolios and many are turning to alternative or liquid alternative investments. Alternatives have historically produced returns with lower correlations to traditional investments (including stocks and bonds), thus offering the potential for greater diversification and improved risk-adjusted returns.
As show below, adding 30% alternatives to traditional portfolios noticeably improved risk-adjusted returns over the past 20 years.
Source: Morningstar and Pioneer Investments for the 20-year period ending 3/31/14. Other time periods may produce differing results. Past performance does not guarantee future results. This chart is for illustrative purposes only and is not meant to represent the performance of any particular investment.
Equities are represented by the S&P 500 Index, a commonly used measure of the broad U.S. stock market. Bonds are represented by Barclays U.S. Aggregate Bond Index, a measure of the U.S. bond market. Alternatives are represented by the Credit Suisse Hedge Fund Index, an asset-weighted measure of hedge funds only and does not include separate accounts. Indices are unmanaged and their returns assume reinvestment of dividends and, unlike mutual fund returns, do not reflect any fees or expenses associated with a mutual fund. It is not possible to invest directly in an index.
Liquid alternatives are alternative investment strategies that provide daily liquidity through vehicles such as mutual funds.
Liquid alternatives aid portfolio diversification by tapping into new sources of returns, such as less mainstream asset classes and nontraditional strategies that are uncorrelated to conventional equities and fixed income securities.
Hedging techniques used in liquid alternative investment strategies can help reduce volatility by cushioning portfolios against extreme market conditions, particularly in down markets. Each technique follows a strategy that explicitly seeks to hedge certain risks, such as interest rate and/or market sensitivity, or focuses on limiting downside risk.
By using a range of hedging strategies and investing in areas and ways in which traditional investments cannot, liquid alternatives offer the potential for enhanced returns.
Once the domain of institutional and high-net-worth investors, liquid alternatives are now bought and sold daily via mutual funds, making them accessible to average investors. Mutual funds offer the added advantages of lower investment minimums, potentially lower fees, no pre-qualifications and efficient tax reporting.
Hedge: A transaction that reduces the risk of an investment by making an offsetting investment in a related security.
Liquid alternative investments can be a worthwhile complement to your portfolio allocation. Depending on your goals, risk tolerance and objectives, you might consider allocating a part of your portfolio to liquid alternatives to take advantage of the potential for increased diversification, risk management and enhanced long-term performance – especially in uncertain markets.
Speak with your financial advisor to determine where alternatives might fit in your investment portfolio.
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