About Alternatives

The severe market downturns of 2000–2002 and 2008 have brought increased attention to the risk and return characteristics of alternative investments. Alternative investments are not new — some have their roots going back many decades. However, what is new is the heightened awareness of what they can add to an investment portfolio, as well as the increased number of products in the marketplace allowing accessibility among a wider range of investors.

Alternative investments can be broadly defined as those that are not traditional investments such as stocks, bonds, or cash equivalents like CDs or money markets. Types of investments that fall into the category of alternatives include hedge funds and managed futures — to name just two.

Alternative Investments can have several attractive characteristics. Two examples are:

Return Opportunities Regardless
of Overall Market Direction
Potential to Reduce Portfolio
Volatility Via Non-Correlated Returns
  • Traditional investments like stocks and bonds are generally reliant on rising markets to profit.
  • Alternative investments can pursue returns in both rising and falling markets.
  • The pursuit of returns in both bull and bear markets is commonly referred to as seeking "absolute returns". Keep in mind that absolute return investments are not intended to outperform stocks and bonds during strong market rallies.
  • The returns of many alternative investments have historically shown little to no correlation to traditional stock and bond investments over the long term.
  • Non-correlated assets may reduce portfolio volatility during difficult market periods.



Goals of Alternatives

There are many potential benefits (and risks) that can be attained by introducing alternative investments into a portfolio. Despite the fact that various types of alternative investments can seem different from one another, many share common objectives. Click on the sections below to explore them further.

 

Portfolio Diversification

The bear markets of 2000–2002 and 2008 have reminded yet another generation of investors of the importance of diversification.

Looking to the institutional investing space — particularly university endowments — one can see how their approach to diversification has shifted over the last 10 years. According to an annual study conducted to monitor investment allocations of several hundred university endowments, from 2005 to 2014, the average endowment reduced their exposure to stocks from 59% to 36% and increased their allocations to alternative investments from 17% to 51%.

 

Endowments Have Sharply Increased The Use of Alternatives Over the last 10 Years

 Average University Endowment

Source: NACUBO Annual Endowment Study 2005, 2014

 

Further analyzing how these endowments allocate their portfolios, we see a significant difference versus a more traditional "moderate" portfolio of 60% stocks and 40% bonds. Endowments have as much as 53% of their portfolio committed to alternative investing strategies.

 

Seeking True Diversification

True Diversification | Alternatives

1. Source: NACUBO 2014 Common Fund Study of Endowments

 

Risk Mitigation

A peak-to-valley decline measures the worst price decline from a historical peak during a specified time frame.

Using month-end values from January 1990 through December 2018, the chart below measures the worst peak-to-valley declines and average annual returns for managed futures alongside several other major indices. Over the last 30 years, the largest peak-to-valley decline for managed futures compares favorably to the largest declines seen in domestic and international stocks, commodities and real estate.

Average Annual Returns and Worst Peak-to-Valley Declines
January 1990 – December 2018

Worst Peak-to-Valley Declines and Average Annual Return January 1990 – December 2018

 

As with any type of investment, alternatives can have risk. This includes risks associated with the use of leverage, short sales, options, futures, derivatives, emerging markets, illiquid securities and limited regulatory oversight. The Barclay Systematic Traders Index is a proxy for Managed Futures performance.

See Glossary of Terms for index definitions and risks.