Alternative Investments – Q&A With Bill Landes by ColumbiaManagement
Bill Landes, Ph.D., Deputy Head of Global Investment Solutions and Head of Alternative Investments, discusses alternative investments and offers some guidance as to why and how investors should consider adding alternatives to their portfolios.
Q: Let’s start with how you define alternatives?
A: Alternative investments are non-traditional approaches to investing in categories such as real estate and commodities as well as strategies such as hedge funds, private equity and alternative betas. Alternative investments have been available for decades, but until recently have been primarily utilized by institutional investors. However, we are now seeing a broader adoption of alternative investments as investors seek ways to generate investment returns with an emphasis on diversification and downside protection. This trend has coincided with alternative investment strategies becoming more available to retail investors through the convenience of mutual funds with daily liquidity.
Q: What is the goal of incorporating alternative investments into a portfolio? Is it to enhance returns or to reduce risk?
A: It’s really a combination of both. The primary goal of investing in alternatives is to generate positive returns over time in order to help investors reach their long-term financial goals. However, because alternative investments offer sources of return that are simply not available from traditional investments, such as stock and bonds, they tend to be less correlated to traditional markets and provide a diversification benefit as well. The goal of an alternative investment portfolio is to provide enhanced returns through non-traditional approaches as well as diversification through low correlation.
Q: What do you mean when you say sources of return not available from traditional markets?
A: Most investors are familiar with owning an equity portfolio where their performance is tied to whether the stock market goes up or down as well as whether the stocks that they own outperform or underperform the market as a whole. Traditional equity funds are long only, meaning they take long positions in stocks and make money if the stocks increase in value and lose money if the stocks decrease in value. An example of an alternative investment is an equity long-short strategy, often used by hedge funds. This might involve taking long positions in stocks that are expected to rise and short positions in stocks that are expected to decline. If the long and short positions are of equal size, then the goal of the strategy is to minimize exposure to the broad market and generate excess returns from the relative performance of both the long and short positions. Long-short strategies can be employed across many different markets such as equities, fixed income and currencies and can focus on different factors such as value, size and momentum. The important point is that these alternative investment strategies have the potential to take advantage of both rising or falling markets and offers sources of return that are not available to traditional long-only funds.
Q: Why should investors consider adding alternative investments to their portfolios?
A: Investors are seeking ways to generate attractive returns while being mindful to ease the impact of volatile markets and reduce overall portfolio volatility. Alternatives offer the potential to do just that. However, their importance in a portfolio may be more relevant today. Since the financial crisis, we have experienced a synchronized rise across global asset classes as a result of improving economic conditions and unprecedented global central bank monetary policy. One of the things we hear from investors today is that they are very concerned about not giving back all the hard earned gains they have accrued over the last several years. With stock markets near all-time highs and interest rates near all-time lows, investors are beginning to rethink the traditional 60/40 stock/bond portfolio. Because alternatives having historically offered potential downside protection during significant equity market declines as well as the potential to capture positive returns in periods of rising interest rates, we believe today’s market conditions make it an opportune time to consider incorporating alternative investments into a portfolio.
Q: What percentage of a portfolio should investors consider allocating to alternatives?
A: Obviously that depends on an investor’s goals and objectives. Our research shows that while adding a small amount of 5% alternative investment exposure to a portfolio may provide some benefit, a more meaningful amount of 20% offers potentially improved results. By allocating a portion from both the fixed income and the equity components of an existing portfolio to alternative investments, it offers the potential to generate attractive returns while mitigating overall portfolio volatility. It should be noted that not all alternative strategies are alike and each may perform differently in different market environments. As a result, we believe that investors might benefit from solutions that incorporate multiple managers and multiple alternative strategies together a single fund with broad diversification and the flexibility to adjust allocations as market conditions change.