A lot of misunderstanding surrounds alternative investments. Some investors still think of them as high-risk, exotic funds reserved for ultra-high-net-worth individuals and sophisticated institutions. However, the reality is that alternatives have a place in nearly every portfolio.
Myth: Alternative investments are more volatile than stocks and bonds.
Reality: While some alternative investments can experience higher levels of volatility than traditional stocks and bonds, as a group, they are no more volatile than any other investment. In fact, many alternatives experience far less volatility than the stock market.
Myth: Alternative investments are a unique asset class.
Reality: Alternatives represent different approaches to investing across a variety of markets and vehicles. A useful way to think about alternatives is to differentiate between their “contents” – the assets or strategies that determine how individual investments might be expected to perform – and their “containers,” the fund structure that will determine transparency and access to capital.
Myth: Investing in one alternative fund will diversify my portfolio.
Reality: Just as adding one stock or mutual fund does not lead to significant diversification, so too a single alternative investment may have limited impact. Investing in only one alternative strategy may provide some diversification benefits, but can also concentrate risks.
Myth: Investors cannot access their money if they invest in alternatives.
Reality: The liquidity of alternative investments depends on the individual investment. Some alternative mutual funds provide daily access to cash. Limited partnerships, on the other hand, can have restrictions from 30 days to longer than 10 years.
Myth: Only institutional investors and ultra-high-net-worth individuals can access alternative investments.
Reality: Individual investors have greater access to alternatives than ever before due to innovations in product structures. Open-end mutual funds, for example, have no-or-low barriers to investing. Other structures, such as registered closed-end funds and unregistered funds, have some limits on who can access them.
Myth: Alternatives failed to protect investors during the financial crisis.
Reality: While correlations across nearly all investments converged during the financial crisis, many alternative investments saw smaller drawdowns than stocks did in 2008.
Myth: Alternatives are too expensive.
Reality: The fees for alternative investments vary and depend on the fund’s structure. An alternative investment’s “container” usually indicates the fees an investor can expect to pay. Partnerships typically entail management and performance fees. Mutual funds charge a management fee but no performance fee.