Alternative Investments Can Be The X-Factor In Your Portfolio

Originally published by BetaShares

As investors, many of us like to be on the lookout for new opportunities that add value to our portfolios and are trying to make sure that our portfolios are protected during market downturns. An often overlooked or misunderstood asset class that can assist in both adding value to a portfolio and provide some protection is alternatives.

What are Alternatives?

Alternative investments are generally considered to be assets that are not one of the more conventional or well-known investment types, such as equities, bonds, property or cash. ‘Alternatives’ can include a wide array of investments from artwork to film and cinema credits, to water and fishing rights to some of the better-known alternatives of hedge funds and commodities.

Despite strong institutional use over the past thirty years, retail investors have been slower to invest in alternatives. This may be changing, however, as from recent experience I have seen a number of sophisticated financial planning houses use alternatives as tools in portfolio construction for their clients.

There are good reasons why retail self-directed investors have yet to take to alternatives, including:

• lack of transparency
• illiquidity
• large minimum initial investment sizes (some start at $500K min)
• lack of accessibility
• being difficult to understand.

Bringing Alternatives onto the pitch

The main attraction for using alternatives is they can add an extra element of diversification into your portfolio, as generally speaking alternatives should be less correlated to the major asset classes of equities, bonds, property and cash – that is: alternatives can be the X-Factor player in your portfolio – when your team is under the pump and you need that break through wicket late in the tea session or to score a try or kick a goal and create something from nothing, this is where you can bring the Alternative on to “bowl from the Members end” or to “come off the bench”.

While there is no doubt that some alternative investments can be difficult to understand, I wanted to focus on one style of alternatives that can be simpler and more transparent – gold bullion and other commodities.

Gold Bullion

Gold bullion can be viewed as the favourable port to go to when storms appear on the investment horizon, due to it generally being uncorrelated to the major traditional asset classes as mentioned above. Gold has tended to perform better than the major asset classes (equities especially) in market sell-offs and in times of higher than usual market volatility, and this is why central banks around the world have been buying gold for the past few years – as a buffer against future economic instability.

In addition to this, gold has tended to work especially well when inflation kicks in – when the value of other assets is being eroded by inflation, the scarcity of gold helps it hold its worth.

Other Commodities

Other than gold bullion, other types of commodities can also be a handy inclusion in portfolios. In the below, I’ll focus on agricultural commodities. Agricultural commodities are an area that I find most share investors have limited exposure to. Whilst Australia is a major agricultural exporter, the local bourse has significantly low exposure to agriculture – being less than 1% of the share market.

Agriculture is a key global sector likely to enjoy a solid long-term or “secular” demand outlook, as the rising global population and improved per-capita incomes are increasing both the quantity and quality of food demanded worldwide. Over the short-term there appears to be particularly good upside price potential, as an unusually extended period of good global growing conditions has pushed many agricultural prices to relatively low levels. And irrespective of short-term price movements, due to the relatively low historical correlation between agricultural sector performance and the Australian equity market more broadly, some exposure to the agriculture sector offers a potentially handy extra source of portfolio diversification for Australian investors.

Lastly, as mentioned, investing in alternatives can be complicated and, like all investments, it’s not without its risks so you may find it worthwhile getting assistance from a professional fund manager. There are a number of very talented and highly skilled fund managers focusing on alternatives here in Australia, many of which will have their own unique investment strategies. Whilst the institutional world and, increasingly, financial planners are embracing these types of managers, they can be very hard for self-directed investors to get access to because, as mentioned previously, some are at capacity or have very high entry levels and fees.

Alternatives are useful diversification tools within investment portfolios. They can offer a potential source of outperformance when traditional asset classes are being sold off and likewise may underperform when the traditional asset classes are outperforming.