Many regard them as nothing more than a “black box” of complicated and risky investment structures. In addition to this, the higher fees and minimum investments often deter potential investors, ruling them out when it comes to investment portfolio creation. For these reasons, hedge funds have traditionally only be open to institutional and high-net-worth individuals.
However, this may no longer necessarily be the case. Despite the reputation that they may hold among much of the market, larger retail investment houses are increasingly turning to a form of hedge fund referred to as an “absolute return” fund. The aim of an absolute return fund is to generate stable returns, no matter the market conditions, using a number of strategies which may include the use of derivatives.
In addition to this, unlike a regular long-only asset management or mutual fund, the absolute return fund is unlikely to have a predefined benchmark or mandate. Instead, they attempt to match the return of a number of asset classes. As a result, the nature of these funds are very closely related to the traditional hedge funds.
Traditionally investors look toward three core asset types, namely equity (as in shares traded on exchange), bond and fixed income/interest, or cash. These three asset classes tend to dominate the majority of investor portfolios for a number of reasons, such as liquidity, lower minimum investments requirements, transparency and wider availability.
A well-constructed portfolio containing a combination of just these three elements has proven time and time again to serve as more than adequate to achieve investment objectives. However, this is far from the exhaustive list of possible investment options available to investors.
There are alternative investments that, although less well understood or utilised, still have a place within an overall investment selection. The list of alternative investments is by no means definitive, but it tends to include, among others, art, wine, antiques, coins, stamps, precious metals and other commodities.
The benefit of such investments is that not only do they hold capital value, but there is also a tangible element which appeals to many investors. Another important factor favouring alternative investments is the low correlation that these have to the more traditional asset classes.
This is due to the fact that the value of these assets is not determined by the same drivers as stocks, bonds and cash. As a result, the negative correlation helps to increase the diversification of the overall investment portfolio. In addition to this, by their very nature these assets tend to price out the majority of investors given the elevated price tag, and they come with very limited tax benefits.
When taking the pros and cons into account, whether alternative investments are relevant to your portfolio or not should be determined on a case-by-case basis. However, in order to undertake this, the investor should have a clear understanding of these investments, and they should be discussed with your financial adviser.