Over the past 30 years, the alternative investments asset class has grown from a small, niche market segment into a more prominent one.
This is especially true among institutional investors seeking to optimize their clients’ portfolios. According to a recent report compiled by investment bank UBS, alternative investments now make up a larger share of portfolios held by institutional investors compared to just a few years ago.
On average, UBS found that large public pension funds hold an average of 15 to 25 percent of portfolios in alternatives, while family offices hold an average of 37 percent in alternatives. Large endowments, such as those held by many universities, appear to be the most aggressive in portfolio allocation, holding between 40 and 60 percent of portfolios in alternatives.
The reason why is clear: Alternative investments offer portfolio managers another option for diversifying portfolios—one with the potential to significantly boost yield over the long term.
If you’re interested in learning how to weave alternative investments into your client investment strategy, it’s important to build the skills needed to succeed. Here are three alternative investment skills you should develop.
Alternative Investment Skills
1. Speak the Language of Alternative Investments
Alternative investments comprise their own distinct asset class, which means they come with their own vocabulary. If you want to work with alternative investments in your career, you need to learn to speak that language. Doing so can not only empower you to better communicate with clients, co-workers, and business partners, but also make the process of researching and evaluating potential investments easier.
First, you should familiarize yourself with the major types of alternative investments you’re likely to encounter. These include:
- Private equity
- Private debt
- Hedge funds
- Real estate
- Commodities
- Collectibles
- Structured products
Second, you should familiarize yourself with investment strategies that are common when dealing with alternative investments, such as distressed debt investing and arbitrage.
2. Analyze Alternative Investment Opportunities
Alternative investments are different from so-called traditional investments in a few ways. These differences can and should impact how you evaluate alternative investments you may be considering for your portfolio.
For example, one of the key differences between alternative investments and traditional investments is that alternatives are less liquid, or harder to sell or convert into cash. This is due to several reasons, including that most alternative investments aren’t traded in public markets.
With this in mind, most alternative investments have longer investment horizons or timelines than traditional investments. UBS notes, for example, that infrastructure funds, which invest in large capital projects, often have an investment horizon of 12 to 15 years. Private equity, meanwhile, typically has an investment horizon closer to 10 years.
Other factors that must be considered include the risk and return relationship for each investment, along with volatility.
3. Maximize the Value of Investment Portfolios
There are many reasons you might decide to incorporate alternative investments into a portfolio. All of them tie back to the value that alternative investments can bring to the table. Two of the most important ways alternative investments create value are by offering enhanced diversification opportunities and potentially higher yields.
Alternative investments offer diversification due to the fact that assets aren’t typically correlated with other popular asset classes, such as the stock market. This can add stability to a portfolio and reduce volatility, especially during periods of economic downturn. They can also offer outsized gains compared to other asset classes, which can compound over time in significant ways.
To understand the power of yield optimization, consider a portfolio of $1 million that’s exclusively invested in index funds over the course of 30 years. If that portfolio realizes an average annual return of seven percent—which is a reasonable assumption in line with long-term, historical returns—then it will be valued at roughly $8,116,000 in 30 years.
Consider that, by adding alternative investments to the portfolio, you optimized yield to boost the average annual return from seven percent to nine percent. This two percent increase in yield would, over time, translate into a portfolio valued at $14,730,000, or almost twice the original portfolio’s value.
Investment returns can never be guaranteed, and it can be dangerous to assume past performance will translate into future performance. This is why proper diversification is key. Building a portfolio that outperforms the broad market without incurring too much undue risk requires strong analytical skills to ensure an appropriate percentage of it is dedicated to alternatives.
Developing Your Alternative Investment Skills
Leveraging alternative investments is an excellent means of diversifying portfolios outside the realm of more traditional investments, such as stocks and bonds, and may offer a path to outsized gains.
As alternative investments take up larger percentages of pension fund, family office, and endowment portfolios, it’s clear that financial professionals seeking to serve those clients must become knowledgeable about them. Taking the time to develop alternative investment skills can empower you to break into the field and realize more value for your clients.
Alternative Investments is an online course offered by Harvard Business School Online that was specifically developed with financial professionals in mind. Taught by HBS Professors Victoria Ivashina, Randolph Cohen, and Arthur Segel, the course lays the foundation needed to leverage the power of this asset class.
Are you interested in exploring the role that alternative investments can play in your career? Learn more about our five-week course Alternative Investments and our other Finance & Accounting courses.
