In fact, McKinsey predicts that flows from retail investors will grow by more than 10% annually over the next five years, while PwC expects alternative assets to grow to $15.3trn (£10.8trn, €13.6trn) by 2020.
Increased risk aversion
In the wake of the financial crisis and with so much uncertainty still remaining (2016 is proving to be the ‘perfect storm’ for uncertainty with the EU referendum, US election, a number of elections in South America…), investors are more risk averse than they were a decade ago and seek investments that will provide long-term, sustainable returns.
Alternatives offer three key benefits: higher return potential – they seek to outperform traditional markets by being continuously active; market protection – unlike traditional ‘buy and hold’ investments, they can profit even when markets go down; and true diversification – alternatives can help lessen the correlation of a traditional portfolio to the stock market which can in turn, help protect it from market volatility.
Diversification conundrum
This point on diversification is key; in the past, when one part of the market went down, generally another would go up. For decades, investors could diversify portfolios across a number of investments to reduce risk and improve returns in the long run.
"Of course certain alternatives – namely hedge funds and commodities – have faced some difficulties in the current market environment."
In recent years however, different parts of the market have started to move together and therefore become correlated with one another. Ideally, an investor wants to avoid this correlation, or at least keep it as low as possible, because if investments are all moving in the same direction, there’s little true diversification.
A lack of diversification increases risk and can lower return, and this erosion in the risk-reducing power of traditional diversification has left many investors with much riskier portfolios than they think. The benefit of alternatives is their ability to create true diversification due to their uncorrelated nature.
Alternatives vs equities
If you need further convincing, the table below paints a clear picture as to the diversification benefits of including alternatives in an investment portfolio. During the fifteen worst quarters of the S&P 500 Index’s performance in the last 30 years, alternatives outperformed equities in all cases.
On average, alternative investments, as measured by the Barclay CTA Index (an index which analyses the performance of managed futures), performed 18.8% better, and in one quarter, this figure was as high as 39%.
Risks remain
Of course certain alternatives – namely hedge funds and commodities – have faced some difficulties in the current market environment which is why we always recommend that only a portion of any portfolio be invested in them – typically between 10% and 40% – and that each alternative option be evaluated on its own merits.
Our portfolio management service, for example, offers seven alternative investment strategies with next-day liquidity, which use computerised algorithms to trade automatically and aim to continually optimise the strategies and take advantage of changing market conditions.
So while this asset class has historically only been available to very wealthy investors and as a result, has meant that some retail investors are still weary of it, we’re in no doubt as to the central role it will play in the investment universe and the global economy in the future.
