There is no doubt that 2022 has been a year of challenges: inflation, supply chain shortages, and war in Ukraine. Included in this mix is the potential for recession in the US. As a result of these, and other factors, we are currently experiencing a bear market in the NASDAQ, with the S&P 500 inching ever closer to the same mark. Additionally, stocks and bonds have been notching a rare simultaneous fall in what haven been the worst performing debt market in 40 years.
Watching your hard-earned savings decline is not easy and it’s understandable to feel anxiety during sharp market declines. You may wonder how to structure a diversified portfolio to mitigate losses.
Understanding the concept of diversification is critical when evaluating your portfolio. On one level, a diversified portfolio should be diversified between asset classes, such as stocks, bonds, and cash alternatives. On another level, a diversified portfolio also should be diversified within asset classes, such as alternative investments.
Recent years have witnessed the mainstreaming of alternative investments for certain accredited investors. In fact, alternative investments are expected to grow from $13.9 trillion in 2020 to $21.1 trillion in 2025.
The impetus behind this projected growth is the belief that alternative investments offer the potential to enhance the risk/reward characteristics of a traditionally diversified portfolio.
"Alternative investments" is an umbrella term for a disparate range of investment strategies and assets that might be best defined as investments that use a different approach from traditional instruments.
Types of Alternative Investments
Private Equity — Seeks to participate in the growth of private companies. Private equity is an illiquid asset class that seeks long-term appreciation away from public markets.
Hedge Funds — Investments that have broad flexibility in the types of strategies they can employ to follow their stated investment objectives.
Inverse Funds/ETFs – Constructs by using various derivatives to profit from a decline of broad equity market or underlying benchmark.
Commodity Pools — Enterprises that attract funds from people who are looking for the pool managers to engage in commodity-related trades.
While today’s portfolios may benefit from some diversification to alternative investments, it should be emphasized that the risk, return, and market correlations will vary widely among them.Consequently, individuals need to consider what their objective is for adding alternative investments and select the appropriate strategy to pursue their needs.