Do You Have the Courage for Alternative Investments?

QUESTION: Should I be looking at alternative investments right now, considering how topsy-turvy markets have been in recent months?

ANSWER: For those who have access, private investments in real estate, gas and oil, or venture-capital endeavors—also known as alternative investments—have generally been good portfolio diversifiers.

In today’s climate, they might be even more valuable.

At first glance, many of these investments appear risky. After all, investing in an oil well or a piece of property that will be held four to eight years is a little daunting. But even a small investment in alternatives can increase the return of your portfolio while reducing the risk.

Alternatives are not highly correlated with the public markets, meaning they tend to go up and down at different times than stocks and bonds. Consequently, adding small amounts to the portfolio smooths out the ups and downs reducing your risk. Additionally, many of the investments also have a higher return expectation than public equities. That’s how adding alternatives to your portfolio can both increases the expected return and decreases the risk.

But I don’t want to invest in things like venture capital and real estate, that sounds too avant garde for me. That’s understandable, but sometimes we must push our comfort zone. Three years ago, when oil prices sunk to $35 a barrel and the industry looked hopeless, AMG recommended some private-capital energy ventures. As you can imagine, those are doing very well today.

With the world seemingly in disarray, it’s a good time to have some extra dry powder and liquidity. But once we have cash and fixed income set, it also may makes sense to allocate 5%-10% of the portfolio to alternative investments. Also, certain investments like gas and oil and real estate act as good inflation hedges.

The key to success with alternatives is moderation and consistency—making small investments in several opportunities over time and then sticking with the plan. It takes courage but it can make your portfolio safer.