Monday , 17 January 2022

True Portfolio Diversification Includes Owning Some Alternative Investments

…From my perspective, true diversification is more than just a balance of conventional investments spanning cash, equities and fixed income. There’s a vast universe of alternative investments out there that may suit your risk profile and are worthy of a closer look. Let’s discuss. 

This post by Lorimer Wilson, Managing Editor of munKNEE.com, is an edited ([ ]) and abridged (…) excerpt from an article by David Wieland, founder and CEO of Realized Holdings, for the sake of clarity and brevity to provide you with a fast and easy read. Please note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

Modern Portfolio Theory is an investment strategy that helps investors manage investment portfolio risk while at the same time seeking increased returns using diversification.

  • MPT posits that markets are more efficient and reliable than investors. According to its creator, Harry Markowitz, you can potentially get better returns. theory, based on increasing the level of risk that you’re willing to take.
  • MPT assumes that investors want the highest returns with the least amount of risk but risk and reward when it comes to investing have a positive correlation; when you invest in low-risk assets like bonds, your returns will generally be lower than when investing in higher-risk assets like stocks. Investors have to find a balance between risk and reward. MPT says this balance can be achieved via diversification.

Conventional investments are things like stocks, bonds, cash and cash alternatives, such as money market accounts and CDs., but we believe a balanced portfolio that contains a variety of asset types, including alternative investments like real estate, can help investors improve returns while managing risk. Let’s explore some alternative investments to consider in a portfolio and the potential return an investor can expect by including them in their diversified strategy…

In the past, alternative investments were only of interest to high-net-worth and institutional investors but, in recent years, they have become more mainstream and begun attracting the attention of everyday investors too.

[The above being said,] keep in mind that alternative investments are riskier than conventional ones;

  • they don’t have a long track record,
  • in some cases, they are less regulated and transparent…and
  • they are often less liquid than conventional assets

but alternative investments can offer:

  • higher returns,
  • and because they’re typically not correlated with the stock market, they can help protect your portfolio from market ups and downs.

Current MPT dictates that a diversified portfolio can contain between 10% and 20% alternative investments, including real estate. Most individual investors are falling well short of that, devoting only 5% to alternative investments, while pension funds and endowments are well above that, with 30% and 50% respectively invested in alternatives. These large investors gravitate to alternatives – and real estate in particular – to further diversify their portfolios and because of the income and yield opportunities real estate provides.

Based on data from Griffin Capital, alternative assets can help enhance portfolio return while managing overall risk and volatility of an investment portfolio. Over the past 20 years, a 60/40 portfolio of stocks and bonds has shown returns around 6.86% but, by modifying that split to 55/35/10 of stocks/bonds/real estate, returns increased to 7.06%. Additionally, adding real estate to portfolios decreased the volatility from 9.90% in the 60/40 breakdown to 9.15% in portfolios with 55/35/10.

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