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Why Every Portfolio Needs Alternative Investments Now

It has never been more important for investment portfolios of all types, sizes, and risk appetites to make material allocations to Alternative Investments.

Accumulating investment capital is typically the result of painstaking, decades-long effort. Such a legacy of hard work, thrift, and careful stewardship needs and deserves to be properly protected, to be all-weathered against ever-emerging threats and sudden downturns.

Significant, Undervalued Risk

Many investors have been lulled into a false sense of security after a protracted run-up in the public equities market over the last several years. Meanwhile, volatility, or market risk due to external and geopolitical events, has notably returned. In tandem with a deeply concerning macro backdrop, many investors have been left woefully susceptible to sudden, significant downturns which can wipe years or decades worth of investment gains off the values of their portfolios. Recovery from such a hit can take as long as five to ten years or more. Indeed, a 40% decline in a portfolio’s value, for example, subsequently requires an almost 70% gain just to get back to where that started. The recent, rapidly retreating bull markets have made investors numb to the very real risks at hand.

Indeed, many investors are underappreciating the degree of geopolitical risk and potential instability in many key developed and emerging economies around the world; leading housing markets have slowed notably; worldwide indebtedness is up dramatically while credit quality has fallen precipitously; equity valuations well exceed pre-crisis levels; growth has slowed; and global trade is markedly less efficient. Caution should decidedly be the watchword of every investor.

What Are Alternative Investments?

Regardless of an individual investor’s risk appetite, no portfolio is today properly diversified, particularly against the return of volatility, without meaningful allocation to Alternative Investments. In contrast to Traditional Investments (public equities and fixed income), Alternative Investments are simply investments that typically have a lower correlation and lower volatility, relative to public markets. The universe of Alternative Investments is large and growing, but its classic sub-asset classes include private credit, real estate, private equity, and hedge fund strategies. A simple way to think of Alternative Investments is that they are almost any investment that is neither public equities nor fixed income.

Why Portfolios Need Alternative Investments Now

Modern Portfolio Theory – first published almost 70 years ago in 1952 – heralded the Traditional diversifying portfolio allocation of 60% equities, 40% fixed income. But the 60/40 portfolio was devised at a very different time with less complicated financial markets and vastly fewer investment products. The 60/40 approach fundamentally expected moderate growth from equities with a consistent shock absorber in fixed income. This “starting point” approach for many portfolios’ asset allocation is inherently insensitive to the critical contemporary reality that fixed income allocations alone no longer properly diversify equities exposure and risk.

This shift has been driven by a host of factors, not least that particularly since the 2008 financial crisis, Central Banks have kept interest rates artificially low, encouraging the corporations of many stocks you may own to fund significant growth efforts with cheap, seemingly endless debt, rather than by raising additional equity. This plentiful, less expensive financing has in many cases, eroded good judgment and market discipline. Consequently, we have seen a dramatic increase in global indebtedness and a precipitous falloff in underlying credit quality. The number of AAA-Rated US Corporates is today less than 10% of the number that existed as the 2008 financial crisis unfolded.

This relatively recent shift in the traditional funding mechanisms of publicly traded corporations has also increased the correlation of a given company’s stock and bond action, that is to say the two now more often move together. And, with increased volatility, those moves can be far more dramatic, with outsized, negative impacts on an investment portfolio. Fixed income, the classic insulator of Traditional-only 60/40 portfolios, is now not only often failing to do its diversifying job within many portfolios, but the artificial cheapness and accessibility of that underlying debt may well have actually exacerbated many portfolios’ overall risk.

Material portfolio allocations to Alternatives – generally at least 20-40% of an overall portfolio – are needed to properly diversify.

More Accessible and Relevant Than Ever

Where Alternative Investments were once only available to and appropriate for very wealthy or institutional investors, Alternative Investments are today accessible and critical for the full spectrum of investor types, from institutional to retail investors.

And, where Alternatives were once almost exclusively illiquid investments with long-term capital lock-ups of five to ten years, there exist a host of options today, including Highmore’s Liquid Alternatives, which achieve that desired lower correlation and lower volatility relative to Traditional public markets, all while providing daily liquidity with full position transparency.

For those investors seeking more specific solutions such as income-generating investments, there exist a number of Alternative private credit options in between those extremes of daily liquidity and long-term capital lock-ups. Opportunities such as Highmore’s Trade Finance Fund, offer quarterly liquidity while engaging in a largely contractual business of providing short-term, self-liquidating, overcollateralized trade financing to strong small and medium-sized enterprises.

Alternatives have moved from the periphery just a couple of decades ago, to a position of equal importance with Traditional Investments within every portfolio. This is the new and foreseeable normal.

Special Thanks to our Contributor

Dipak Jogia

Managing Partner, Highmore

Highmore is an alternative asset management firm with an opportunistic approach focused on growth stage and capacity-controlled investments in both public and private markets.

Table of Contents

  • Significant, Undervalued Risk

  • What Are Alternative Investments?

  • Why Portfolios Need Alternative Investments Now

  • More Accessible and Relevant Than Ever


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