Alternative investments are all the rage these days. Mutual fund companies are falling all over themselves to sell financial advisors and their clients on “liquid alts” or hedge fund-like strategies with the daily liquidity offered in a mutual fund wrapper. Hedge funds were allowed to advertise due to a change in the rules last year. The financial press is filled with articles about alternatives and the fund companies are offering numerous webinars and conferences covering them.
Are alternative investment strategies right for your portfolio? I have no idea but here are some questions to ask as well as some information for you to consider.
What is an alternative investment strategy?
Alternatives are basically investment vehicles that aren’t purely stocks, bonds, or cash. The purpose of alternatives is generally to diversify an investment portfolio. Ideally these strategies will have a low correlation to other investment vehicles in your portfolio. Examples of alternative strategies include:
- Hedge funds
- Unconstrained fixed income
- Macro strategy funds
- Commodities and managed futures
- Real estate
- Precious metals
- Long/short equity
- Convertible arbitrage
- Private equity
- Vulture funds
- Venture funds
- Merger arbitrage
As mentioned above, these strategies are available in the more traditional hedge fund format, as mutual funds, ETFs, and as fund of funds in each of these formats.
Consider this before investing in alternatives
Before buying an alternative fund or product here are a few questions to consider:
- Do you understand the underlying investment strategy?
- What benefit will this investment provide to your overall portfolio? Reduced volatility? Low correlation to other holdings?
- What are the expenses? Are they justified given the expected benefit of investing in this alterative fund?
- Are there any restrictions on redeeming your investment? Typically (but not always) with a mutual fund or ETF the answer is no, hedge funds may have a lockup period or other restrictions.
- Have this fund’s performance been tested in real market conditions or just back-tested on a computer?
- Who’s managing the fund? What is their background and track record?
I am actually a fan of alternatives and have used several mutual funds of this type for a number of years.
Remember though, large endowments like those of the Ivy League schools use alternative investments extensively and successfully. Unlike you they have access to the expertise needed to perform proper due diligence. Does the financial advisor recommending these funds to you really understand them? Be sure that you do before investing in any alternative investment product.
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