Alternative Investments – Portfolio Planning Characteristics

This article focuses primarily on real-asset investments, and this section is designed to highlight some of portfolio planning characteristics of physical assets when considered as part of a well-diversified and balanced portfolio of investments, as well as some of the inherent risks to be considered when allocating investment capital to specific, niche investment sectors or projects.

Whilst real or hard-assets offer a number of significant benefits including reduced volatility, tangible asset values and the potential for superior investment performance that is not reliant on the performance of traditional financial investments, potential investors must give equal consideration to the potential for relative illiquidity, operational or management risks specific to the asset class, and of course counterparty risk exposure when investing in assets that require on-going expert management in order to maximise returns and minimise downside potential.

Portfolio Planning Advantages

Every asset class exhibits different characteristics when considered from the point of view of an Investor or Financial Planner, and Investors invariable choose to invest in specific assets in order to achieve specific goals such as risk mitigation, portfolio insurance, superior returns and a hedge against inflation or some other potential economic impact on the value and performance of their portfolio.

Here we look at some of the broad portfolio planning characteristics associated with a range of physical assets considered as alternative investments.

Capital Values

By their very nature, physical assets retain a disposal value throughout most economic circumstances, and whilst asset values will fluctuate from time to time, Investors allocate capital to hard-assets in order to underwrite the value of their portfolio and insure against the possibility of the values of listed financial assets falling sharply at any given moment. In fact, certain assets such as gold hold a ‘safe-haven’ appeal, often rising in value when stock markets falls as Investors sell equities and buy gold.

Non-Correlated Returns

The fundamentals that support value growth and income associated with real-assets are often far removed from the fundamentals that support traditional investments. Often, alternatives share a direct negative correlation with the performance of equities and bonds, affording investors the opportunity to balance their portfolios and make gains when other portfolio components lose value or underperform. This strategy is sometimes referred to as portfolio insurance.

Diversification

Key to risk-mitigation in financial planning, diversification simply means spreading ones investment risk across abroad selection of holdings, reducing the likelihood that too many eggs are held in one proverbial basket. Diversifying an investment portfolio into a range of holding across different sectors and assets reduces the risk that poor performance in any one asset will have too big an impact on the portfolio as a whole.

Inflation Hedge

A number of alternative investment assets share a strong positive correlation with inflation, rising in value faster than the prevailing rate of inflation. This effectively mitigates the impact of inflation on the real value of investment portfolios. Pension funds and university endowments, along with insurance companies and other institutional investors buy into long-term investment assets such as farmland and forestry for this very reason.

Superior Returns

As detailed in the chart overleaf, many alternative investment assets have outperformed traditional investment assets over the long-term by some considerable margin. Whilst all sectors and strategies carry inherent risk, carefully selected and well-managed real-assets have been shown to generate superior investment returns for the Investor capable of tolerating short term price fluctuations and long-term investment horizons. Operational asset like property also generate income useful when other income assets like cash deposits underperform.

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