“Those who do not learn from history are doomed to repeat it”
After experiencing the worst global financial crisis of 2008 and passing 12 year anniversaries of the crisis, there has been a good opportunity to reflect and learn what had actually happened and can it happen again. With what happened back in 2008, few lessons must have been grasped as of now that all investments are not the same, not to overemphasize the investments in stocks, bonds and cash, expanding the toolbox used for constructing the portfolio by broadening from stocks, bonds and cash to stocks, bonds, commodities, hedge funds and real estate depending on the individual investor’s objectives.There was a time back then where most investors had the notion that alternative investment industry belongs only to high net worth individuals and institutions but in the present scenario, the alternative investment industry has evened out.
With traditional or conventional investments being made and investors still not learning from past and not engrossing on constructing a well-diversified portfolio which mitigates volatility of the portfolio as a whole, the investors are losing the opportunity of survival in bear markets. In the past, when one part of the markets went down, generally another would go up. In the past, investors could diversify portfolios across investments like large-capitalization stocks and small-capitalization stocks to reduce risk however, with the ever unpredictable market conditions, many parts of the market have started to move together. Investors still are aligned to the self-serving theory that postulates investment in cash, bonds and stocks as an effective allocation strategy, which now needs to exit and a new modernised and refined approach towards alternative investments is required. These alternative investments are broadly private equity, Hedge funds and real estate, managed futures and commodities. Traditional investment products no longer suffice for diversification. In this ever changing world, alternative investments would provide both diversification and also help in generating alpha i.e. risk adjusted return. The alternative investments can provide a lack of correlation to the conventional asset classes including bonds, listed stocks, cash, etc. aiding them in reducing the overall standard deviation for the portfolio as a whole.
The major reason of investors ending up with lesser or no returns is the failure to seek a portfolio which has asset allocation having zero or near zero correlation .Investors would do better if a large portion of asset allocation is made to alternative investments. The ideal asset allocation will have the highest possible alpha for the desired level of risk. The less correlated the assets are the more shall be the diversification benefit. Therefore, this can be understood as of now that asset allocation in a portfolio should be done in such a way that each asset does not behave in an exact similar way and there should also be a blend of low correlation alternative investment in the portfolio so that bear markets can be survived, market inflation can be hedged since they provide liquidity and tactical commodity exposure. Alternative investment comes up with two-fold benefits: firstly by mitigating risk by working along asset classes which will move in a perfect march with each other and other benefit that alternative investment managers aim to deliver a net positive alpha. The disadvantages of alternative investments are that they are illiquid and lesser information is available for these investments than what is available for traditional investments.
According to a study by J.P Morgan, individual investors have earned a 1.9% annual return over the past 20 years. It is quite evident that investing in individual stocks and bonds is not working out well for the average individual investor. Yet, people are overconfident and like to think that they are special. They will surely do much better than average.
The alternative investments can add value to an investor’s portfolio since they are uncorrelated with the traditional market returns by ensuring that each asset does not crash in a tandem. Thanks to modern technology and innovative investment vehicles, many alternative asset classes are accessible to everyday investors with everyday account balances — not just to institutional managers who possess million dollars. The opportunity set to all the investors have evolved.
However, it isn’t all sunshine and rainbows just because an asset is alternative it cannot be good always however it can be best described as being desirable always. Like all other investments even alternative investments need to be scrutinised with regard to associated costs and risks. For instance, like the limited liquidity drawback of alternative investment can be ignored for investors until they need money. Before diving into any conclusions, one must be comfortable with the concepts of investment and ensure that allocation is appropriate to their investment goals and that they can manage illiquidity of such alternative investments and also ensure that the portfolio is well diversified with other asset classes also.