For the second year in a row, I recently attended the National Conference on Alternative Investment Strategies. An alternative investment strategy involves investing in financial products other than traditional stocks and bonds. The primary purpose of this approach is to reduce the volatility of a portfolio, manage risk and enhance the return over time. This is accomplished by investing in products that are not highly correlated with stocks and bonds.
The practice of diversifying a portfolio by using alternative investments began shortly after the 2008 financial crisis, which saw the US stock market decline by more than 50%. Previously, it was thought that diversifying through investing in a variety of sectors and equity styles was sufficient. Unfortunately, in the 2008 crash most stock sectors and styles plummeted together.
The key to an alternative investing strategy is the concept of correlation. Correlation measures the relationship, if any, between two different investments. If two types of investments move in the same direction, they are positively correlated. If the investments move in opposite directions, they are negatively correlated. And if the two investment types bear no relationship at all to each other, then they are uncorrelated.
The idea of alternative investments is to invest in financial products that will reduce the overall correlation with the stocks and bonds held in the typical portfolio. While the ultimate goal is to see the entire portfolio experience strong growth over time, this alternative strategy dramatically reduces the wild swings that occur along the way.
A few examples of alternative investment products are Managed Futures, Master Limited Partnerships (MLPs), Long/Short Equity Funds, Private Equity, Merger Arbitrage and Inverse Fixed Income Funds. I will be blogging on these and other alternative investment strategies over the next few weeks.
If you’re interested in exploring how an alternative investment strategy could reduce the volatility and risk associated with your portfolio, please call or email me.