Alternative Facts: How Alternative Asset Classes Are Improving Portfolios

Enter alternative assets: hedge funds; agricultural land; real estate; private debt and private equity; and infrastructure assets, just to name a few. These nontraditional asset classes have increased in importance in institutional portfolios, thanks to their diversifying effect and ability to improve risk and reward dynamics. In this paper we discuss the types of alternative assets that are becoming more commonplace, the benefits and drawbacks of owning them, and will explore why investors are increasingly allocating capital to them.

Breaking Down Alternative Assets

The major benefit of alternative assets is that they are less correlated or sometimes even negatively correlated to traditional asset classes such as public equities and bonds. Thus, adding them to a portfolio provides a significant boost to the risk/return profile, which we’ll demonstrate soon. Moreover, the returns from alternative assets are often linked to inflation, helping to provide a modicum of protection to the real value of portfolios. Finally, because of the lack of retail investors in the space, alternative assets are less crowded than equities and bonds; this results in a less efficient market and therefore more opportunities for experienced managers to profit.

It’s also important to understand the major drawbacks of alternatives in general. For example, because of a lack of a marketplace, alternative asset pricing is performed through valuations with built-in assumptions instead of being priced simply off the market bid for the asset as with publicly traded investments. This can result in increased opacity in the alternative asset market.

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