Learn About the Role of Alternatives in a Portfolio
- Potential benefits of alternative investment strategies
- Why alternatives have become popular with investors
- How to incorporate alternatives in a portfolio
Three potential benefits of alternative investment strategies
As part of a well-diversified portfolio comprised of different asset classes, alternative investments can help investors pursue attractive returns. Traditional equity and fixed income investments have long been considered the key components of a well-diversified portfolio. While this approach to asset allocation can deliver satisfactory performance, investors may be able to strengthen their returns and enhance diversification by incorporating a broader range of investments that include alternatives. Below are three potential benefits.
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Diversification
Diversification is key to many successful investment portfolios. Since alternative investments typically have a low or negative correlation to traditional investments, meaning they typically do not move in lockstep with stocks and bonds, they can help diversify a portfolio.
By spreading capital across multiple investment types, investors may be able to reduce the risk of losing overall portfolio value in times of a market downturn or when a particular investment underperforms. It is important to note that diversification does not ensure against loss. It is a tool to help manage risk.
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Higher potential returns
Because alternative investments may be more complex and less frequently traded, they offer the potential for higher long-term performance than traditional investments.
However, alternatives’ returns are highly dependent on the type of alternative investment chosen. Return targets differ across investment types, and performance across funds of the same strategy can even vary significantly. This disparity underscores the importance of due diligence when investing in any alternative strategy. Leveraging specialists who have the resources to scale, source, and evaluate opportunities globally, as well as a proven performance track record, can be a valuable approach.
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Downside risk mitigation
The events of 2008-2009 demonstrated that conventional diversification strategies are not enough to protect against market volatility. Because alternative investments typically don’t follow the same performance path as traditional stocks and bonds, they may provide investors with a hedge or way to mitigate risks when public markets are volatile if those investors are sufficiently diversified and uncorrelated. For example, alternative strategies may employ techniques designed to profit when an asset depreciates in value, such as short-selling, or hedging strategies which may offset the risk of unexpected price movements.
During periods of economic and market uncertainty, many investors may find it beneficial to look beyond traditional asset classes for new sources of diversification and returns.
Many types of alternatives have historically helped to minimize downside risk while delivering the potential for attractive returns in challenging equity and fixed income markets. For this reason, many investors have been supplementing their core stock and bond allocations with alternative investments as a way to potentially enhance portfolio stability and pursue their return objectives.
The three steps below can help investors allocate to alternatives:
How much should an investor allocate to alternatives?
The thoughtful integration of alternatives into a traditional portfolio requires a focus on an investor’s specific goals and risk tolerance, as well as his or her comfort with long-term, illiquid investments.
Looking at High-Net-Worth (HNW) investors (those with $5 million or more in total investable assets) showed an average of 9.1% of assets allocated to alternative investing options in 2022, up from 7.7% in 2020, and financial advisors expect this to increase to 9.6% in 2024, according to a report by research firm Cerulli Associates.1
1 The Cerulli Report – U.S. High Net Worth and Ultra High Net Worth Markets 2022: Shifts in Alternative Allocations January 17, 2023 ↩
Disclosures
A word about risk: All investments contain risk and may lose value. Alternatives involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. Investments in illiquid securities may reduce the returns of a portfolio because it may be not be able to sell the securities at an advantageous time or price. The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility. Private credit involves an investment in non-publically traded securities which are subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investments in Private Credit may also be subject to real estate-related risks, which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factors beyond a manager’s control. Diversification does not ensure against loss.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world.
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