Monday, November 23, 2009

Alternative assets

Alternative assets have an important role to play in achieving portfolio diversification.  To start, defines alternative assets by examples including real estate, commodities, collectibles and private equity.  We would expand that definition to be non-traditional holdings (i.e. not stocks, bonds or cash) that over time perform in a fashion differently than traditional portfolio assets.

It is this lack of performance correlation with stocks, bonds and cash that makes alternative assets attractive to portfolio construction.  The extreme market volatility of 2008 and early 2009 provides a good opportunity to view which alternative assets in fact did perform substantially different than stocks and bonds.  In such market duress some of the so called alternative assets, including many hedge funds, turned out just to be traditional assets with high levels of leverage, thereby increasing the risk of portfolios where they were used. 

Frequently, but not always, alternative assets also are less liquid than traditional assets (for example, it is easier to sell a stock than an apartment building).  However, there are some alternative assets that are also liquid and are can be purchased in an open-end mutual fund format.

Informed investors may well begin to use alternative assets, particularly those that offer liquidity, to reduce overall portfolio fluctuations in some of the future volatility that many market experts expect to see.