Diversified, risk-managed, low cost, and tax efficient: These are the primary characteristics that most investors look for in a portfolio. But checking all of those boxes can be a little tricky when so many traditional investments seem to share downside correlation. Finding an asset mix with low correlations can help protect against volatility or even steep market declines, and sometimes alternative investments can help us achieve that mix.
“Alternative investments” is a bit of a catch-all phrase used to define any investment outside of the more traditional stock and bond markets. Hedge funds are probably the best known alternative investments, and newer products like cryptocurrencies are starting to fall into that category as well, but there are also more familiar asset products, such as real estate and private debt, that are also considered to be alternative investments.
Both real estate and private debt can have a low correlation to equities and their inclusion in a portfolio can give us lower volatility and even enhanced returns. Real estate investment trusts (REITs) have actually outperformed the S&P 500 over the past 20 years, returning an annual average of 11.8% vs 8.6% for the S&P 500, generally with lower volatility.
The popularity of REITs, though, has increased their correlation to stock markets. Because of this, we prefer to invest in private placement funds. These funds can avoid market pressures on price and volatility that publicly traded REITs are subject to, while still giving us access to institutionally managed real estate.
Private debt is a rapidly growing market that has performed well in the past few years. This market segment exploded after the Great Recession as traditional lenders such as banks greatly reduced their business lending. This left open an opportunity for investors to step into private lending, expanding a segment that will grow to over $1 trillion by 2020. Strong returns coupled with low correlations with traditional markets have made private debt an attractive portfolio option.
It is important to note that alternative investments are not for everyone. Returns and volatility can vary greatly and these investments are often far less liquid than their traditional counterparts. But for those investors interested in exploring outside of the traditional investment world, alternatives can provide great returns while adding an additional layer of protection to a portfolio.