This has led to significant interest in investments that may be able to help cushion portfolios during times of market weakness. In my experience, alternative investments, due to their unique performance characteristics, can serve this purpose.
Given this recent increased interest, I will be writing a series of blogs this summer covering the basics of alternatives (or alts, for short), with an emphasis on those available via mutual funds. I hope to provide an opportunity for investors to get fully up to speed on this topic and be well-prepared for any market turbulence as we head into the second half of 2018.
What are alternative investments?
While there is no universal definition, Invesco defines alternatives as investments other than publicly traded, long-only equities and fixed income. By design, this definition is intentionally broad and inclusive, and it includes investments that have any of the following characteristics:
- Investments that engage in “shorting” (i.e., seeking to profit from a decline in the value of an asset) such as global macro, market neutral and long/short equity strategies.
- Investments in asset classes other than stocks and bonds, such as commodities, natural resources (i.e., timberland, oil), infrastructure, master limited partnerships (MLPs), and real estate.
- Investments in illiquid and/or privately traded assets, such as private equity, venture capital and private credit.
Liquid versus illiquid alts
At a high level, Invesco divides the universe of alternatives between liquid and illiquid assets.
- Liquid alternatives predominantly invest in instruments that are frequently traded, regularly priced and provide investors with the ability to redeem their investment on a regular basis. Alternative mutual funds and most traditional hedge funds are two examples. Alt mutual funds are generally available to any individual or institutional investor (i.e., pension plans, foundations, endowments and sovereign wealth funds). Traditional hedge funds, however, are typically only available to institutions and high-net-worth individuals (those with a net worth of more than $5 million).
- Illiquid alternatives predominantly invest in instruments that are privately traded, priced on a periodic basis (often quarterly) and require investors to hold the investment for a prolonged period (typically several years) with little to no ability to redeem prior to maturity. Private equity, venture capital and direct real estate are examples — these are typically offered as private placements and are only available to institutional and high-net worth individual investors.
Alternative assets versus alternative strategies
Invesco further divides alternatives between asset classes and investment strategies:
- Alternative asset classes are investments other than stocks and bonds. Real estate, commodities, natural resources, infrastructure and MLPs are all examples. The performance of an investment in an alternative asset class often follows the performance of the asset class as a whole — for example, as commodities rise and fall, commodity mutual funds tend to follow. Investors in these asset classes are often looking for a hedge against inflation, equity-like returns, and attractive levels of current income.
- Alternative investment strategies generally have considerable investment flexibility. The manager can often trade long and short across multiple markets and asset classes such as stocks, bonds, currencies and commodities. Common hedge fund strategies such as global macro, long/short equity, market neutral, managed futures and unconstrained fixed income are all examples of alternative strategies. The ability to short means that these strategies have the potential to generate positive returns (or limit losses) in a falling market environment.
Next in the series
Now that we know what alternatives are, my next blog will further explore reasons to consider an investment in alts. In the meantime, to learn more about Invesco and our alternative products, please visit invesco.com/alternatives.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
Short sales may cause an investor to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, exposure to potential loss is unlimited.
Alternative investments can be less liquid and more volatile than traditional investments such as stocks and bonds, and often lack longer-term track records.
Alternative products typically hold more nontraditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.
The Invesco DB Com Indx Trckng Fund (DBC) closed at $17.27 on Friday, down $-0.43 (-2.43%). Year-to-date, DBC has gained 3.97%, versus a 4.26% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Invesco.