If historically alternatives have provided diversification against both equities and bonds, from a performance perspective it is unlikely to see them consistently outperforming equities over the long term.
"Therefore," Bragazza says, "especially in higher risk portfolios, their use is more constrained by the fact that they struggle to keep up with equity returns.
“However, in the context of more balanced and conservative portfolios, alternatives can help in providing diversification while delivering returns above cash and fixed income.
“Therefore, cash and short-term bonds might represent appropriate funding sources for alternatives, especially if investors seek diversification without compromising on returns.”
Managing risks
With alternative assets tending to be less liquid than more conventional investments, they should only account for a small proportion of most investment portfolios, or at least money investors who can afford to tie up for an extended period, says Hyett.
He adds: “It’s also important that investors understand the additional risks that exist in alternative investments.
“However, for money that is expected to be invested for the long term – perhaps as part of a pension – alternative investments have the potential to enhance overall returns. That is particularly true for wealthier, more sophisticated investors.”
While alternative investments offer certain benefits, they can also bring risks that investors need to be aware of.
For example, while offering a wider range of opportunities not always available through traditional markets, this does bring added challenges around liquidity and costs, which during times of market distress can hamper the return profile.
However, many of these investments are specifically designed to be held over the long term, and are not for speculating.
“As such, alternatives should, like equities and bonds, ride out periods of volatility and bring considerable value to a multi-asset portfolio that is looking to diversify its returns and add ballast,” Doherty says.
So with alternative investing, one conventional rule still applies: higher returns generally come with higher risks.
But in contrast to conventional assets, these may be more difficult to capture due to leverage, shorts, and the use of complex derivatives that may amplify gains but also losses.
However, historically, Bragazza says he has noticed that alternatives, with the exception of commodities, tend to have positive excess return versus cash over a three-year time horizon while exhibiting lower volatility and drawdowns than equities.
Additionally, the historical distribution of these excess returns may be significantly different and this implies a certain degree of caution on the investors' side.
“For example, although managed futures have historically delivered positive excess returns above cash over a three-year period, they tend to exhibit a wider range of outcomes than more stable strategies such as equity market neutral and merger arbitrage and their volatility profile is more similar to equities than to bonds,” Bragazza adds.
