Alternative Investments could Boost Investors’ Portfolios as Traditional Assets Face Headwinds

Investors’ expectations of returns on stocks and bonds—as well as the diversification potential between the two asset classes—are being challenged by high inflation and tightening monetary policy. In this environment, investors are becoming increasingly interested in alternative investments to further diversify portfolios.

Alternative investment strategies, such as those focused on hedge funds, private debt and real estate assets, have long been appealing as a potential source of higher yields, lower volatility and returns uncorrelated with stocks and bonds. Still, such strategies are out of reach for many individuals and typically have been reserved for institutional, ultra-high-net-worth and accredited investors.

That is now changing. A host of innovative investment vehicles has recently become available to a wider range of sophisticated investors. They tend to offer improved liquidity, lower investment minimums and simpler tax-reporting requirements, among other features that render them more investor-friendly.

Interval funds invest in various asset classes, most commonly in credit. They do not trade on an exchange but offer investors the chance to redeem shares at certain “intervals,” such as quarterly or annually. In exchange for accepting this illiquidity, individual investors gain access to institutional-level strategies that can offer a potential return advantage and further diversification, while getting the benefits of greater regulatory oversight, lower investment minimums and less-complex tax reporting.

Business development companies (BDCs) provide direct, privately negotiated senior loans to middle-market companies. They aim to generate high current income through multiple sources, like investments in direct loans are less liquid than traditional fixed-income investments and, for that, offer a premium.

Real estate investment trusts (REITs) offer investors access to a portfolio of commercial real estate assets without having to deal with tenants. This strategy aims to provide an income stream with low correlation to stocks and bonds, while serving as a potential hedge against inflation.

Registered funds of funds (FOFs) are multi-manager investment vehicles that invest in portfolios comprising other funds. Registered FOFs typically have lower income requirements and minimum investment amounts than private FOFs.

Specifically, registered funds of hedge funds offer access to multiple hedge fund strategies. Hedge funds as an asset class have proven to be resilient, particularly during periods of significant equity market volatility and drawdowns.

While many of these registered offerings may be attractive, investors need to remain selective and fully understand the benefits and risks, particularly as they relate to illiquidity. As we enter the next phase of the economic cycle, we expect the evolution of the alternative landscape to continue and the suite of product offerings to mature and expand.