- Effectively allocating to alternative investments requires consideration of how different strategies might affect a portfolio.
- Many alternative strategies have considerable flexibility in executing trading ideas. Therefore, even within the same category, strategies may follow significantly different approaches.
- Registered alternative investment vehicles help provide individual investors with increased access to alternative investments.
Unlike equities and bonds, which tend to group into neat categories based on defining characteristics and factors—such as large-, mid-, or small-cap equities or corporate, municipal, or government bonds—alternative strategies are more nuanced and varied. They can be difficult to group into narrowly defined categories, and there are rarely absolutes when talking about the characteristics of alternative investment categories.
However, allocating to alternative investments requires consideration of—and a framework for—categorizing different strategies. One approach is to consider the source of returns of different strategies and classify accordingly into:
- Alternative markets
- Alternative investment approaches
- Absolute return
The alternative investment landscape
Source: John Hancock Investment Management, June 2023. REIT refers to real estate investment trust.
Alternative markets comprise nontraditional markets, such as private equity, private credit, and real assets, including commodities, infrastructure, timberland, and farmland. Funds in this category typically use long-only strategies to invest in these alternative markets.
Anticipated performance characteristics:
- Most real assets typically offer return potential comparable to equities and, as such, may have comparable risk.
- Private equity and credit markets typically offer an illiquidity premium, which provides an incremental return that compensates an investor for owning an asset that is not highly liquid. These asset classes also typically provide higher potential return compared with public markets, with commensurate risk.
- Strategies in the alternative markets category tend to provide only moderate diversification potential.
- The main objective of these strategies is to align with equity returns during bull markets, while offering distinct and at times potentially improved, risk-adjusted returns.
Alternative investment approaches
Alternative investment approaches refer to strategies within traditional markets that share similar return drivers yet employ distinct trading styles to help generate differentiated sources of alpha.
For example, a long/short equity strategy has long exposure to stocks, similar to traditional equity, but uses short positions to potentially provide an additional source of alpha. Other nontraditional strategies include option writing or unconstrained strategies.
Anticipated performance characteristics:
- While return expectations within this category may vary, a common aim is to help generate returns similar to equities while potentially maintaining lower levels of risk.
- These strategies have moderate diversification potential.
- Some strategies may offer protection in down markets.
Absolute return strategies rely primarily on manager alpha to generate potential returns through investments in both traditional and alternative markets. As such, some of these strategies may have little to no market exposure. Strategies in this category include relative value, managed futures, global macro, and event driven. Derivatives, including futures, swaps, and options, are often used.
Anticipated performance characteristics:
- These strategies often target positive absolute returns in all market environments.
- They may have low and potentially negative correlation to traditional markets.
- Diversification is the primary potential value of these strategies.
Categorizing alternative strategies aims to contextualize distinct return objectives, anticipated volatility, and correlation, which helps investors to better understand the conditions under which various strategies may improve risk-adjusted returns. While some strategies are only available to accredited investors and qualified purchasers, registered, liquid alternative vehicles are broadening the ability for all investors to access alternative investments.
The growing accessibility of alternative investments
Traditionally, alternative investments were largely limited to institutional investors or high-net-worth individuals due to their complexity, higher minimum investment requirements, and limited liquidity. However, with regulatory changes and the emergence of registered alternative investment vehicles, these strategies are becoming more accessible to retail investors and the growing mass affluent segment who are increasingly interested in investing in alternatives. Knowing how to navigate the alternative investment product landscape is an important aspect for financial professionals, particularly as registered alternative investment vehicles span the liquidity and regulatory spectrum and can hold a mix of liquid and illiquid assets.
Registered alternative investment vehicles across the liquidity spectrum
Source: John Hancock Investment Management, June 2023.
The growing accessibility of alternative strategies is enabling a wider audience to participate in previously exclusive investment opportunities, diversify portfolios, and potentially benefit from the unique risk/return profiles that alternative strategies may offer; however, investing across the alternative investment landscape can be complex. Partnering with an experienced investment firm with a history of investing in alternative investments and private markets, alongside public markets experience and operational expertise, can be crucial to success in this diverse asset class.
Find out more about investing in alternatives.
Alternative investments by their nature involve a substantial degree of risk, including the risk of total loss of an investor's capital. Further, alternative investments are subject to less regulation than other types of pooled investment vehicles, may be illiquid, and cannot assume that investments in the asset classes identified will be profitable or that decisions we make in the future will be profitable. Alternative investments may also involve significant use of leverage, making them substantially riskier than other investments.
Alternative investing involves substantial risk and there is an opportunity for significant losses. The products may not be suitable for all investors. Compared with a traditional mutual fund, an alternative fund typically holds more nontraditional investments and employs more complex trading strategies. Investors considering alternative mutual funds should be aware of their unique characteristics and risks. Alternative investments may also have limited performance information, low liquidity, and unproven strategies with unknown risks.
Exposure to investments in commercial real estate, residential real estate, transportation, healthcare loans, and royalty-backed credit and other asset-based lending, including distressed loans, may also subject the fund to greater volatility than investments in traditional securities. Investments in distressed loans are subject to the risks associated with below-investment-grade securities. In addition, when a fund focuses its investments in certain sectors of the economy, its performance may be driven largely by sector performance and could fluctuate more widely than if the fund were invested more evenly across sectors. The fund’s investment strategy may not produce the intended results.
Diversification does not guarantee a profit or eliminate the risk of a loss.
Alpha measures the difference between an actively managed fund's return and that of its benchmark index. An alpha of 3, for example, indicates the fund’s performance was 3% better than that of its benchmark (or expected return) over a specified period of time. A long position is an investment that is purchased with the expectation that it will increase in price over time. A short position is an investment that is purchased with the expectation that it is likely to fall in price in the near future. Futures are derivative financial contracts obligating the buyer to purchase or the seller to sell an asset at a predetermined future price and date. Swaps are over-the-counter derivative agreements between private parties to exchange the cash flows or liabilities from two different financial instruments. Options are contracts that give the contract holder the right to buy or sell a financial product at an agreed-on price for a set period of time.
This material is for informational purposes only and is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and our representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in our products and services.
The views presented are those of the author(s) and are subject to change. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index. Past performance does not guarantee future results.