In a market environment of retreating stock prices, a flight to safety in fixed income sectors, and concerns about both the future course of the global economy and central bank policy, interest in alternative investments is likely to remain high.
Alternatives come in many varieties designed to address specific portfolio needs. To make sense of this variety, it is helpful to compare the long-term performance of alts with each other, and with traditional investments, to identify their characteristics.
We conducted a research study to gain a better understanding of how different alternative strategies may behave in different environments. We think this understanding is essential to utilizing alts as an effective source of diversification over market cycles.
In an earlier post, we outlined our approach to classifying alternatives by investment objective. Today we want to highlight the returns and volatility of the index proxies that we selected to represent the objectives.
This graph plots return and volatility data for the 20 years through the end of 2013.
These results can help us begin to shape expectations for investment performance from alternatives. Two of the objectives stand out on the extremes of the chart:
• The alternative Return Enhancer objective has nearly the highest volatility and the highest returns.
• Traditional bonds have the lowest volatility and nearly the lowest returns.
Risk Reducer/Volatility Dampener merits attention
The other three alternative objectives — Inflation Hedge, Risk Reducer/Volatility Dampener, and Zero Beta/Zero Correlation — fall in the middle. Each one has demonstrated lower volatility than stocks and higher volatility than bonds, while their returns varied. As the graph shows, the Risk Reducer/Volatility Dampener objective has one of the highest levels of return relative to its risk.
Of course, past performance is no guarantee of future performance, but the 20-year data hints at the diversification that a long-term position in alternatives might offer.
You can find additional insights in our research study, “Alternatives in Action.”
Alternative investments may be subject to market risk, currency risk, foreign investment risks, liquidity risks, higher fees and expenses, regulatory restrictions, and volatility due to speculative trading and use of leverage.