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The Rise of Alternatives

Over the past few years, money has poured into assets that aren’t stocks and bonds. Here’s how alternatives – infrastructure, real estate, private equity and more – can help.

 

Date: October 6, 2017

There’s more to investing than stocks and bonds. Since the recession, interest in alternative investments – such as real estate, infrastructure, commodities, private equity and private debt – has soared. Pension funds have been taking advantage of these long-life, often uncorrelated-to-the-market assets for years, but retail investors have only just started asking for these types of investments.

Why the interest? It’s because these kinds of assets – toll roads, airports, commercial buildings and more – tend not to move exactly in line with the markets. “Alternatives provide different return and risk patterns that are less correlated, or uncorrelated, to traditional asset classes, improving diversification in an investment portfolio,” says Allan Seychuk, Mackenzie Investments Vice-President of Product.

Easier access to alternatives

It wasn’t long ago that alternatives were the exclusive domain of high-net-worth and institutional investors, but several mutual funds and exchange-traded funds have recently brought these kinds of investments to the masses. Such funds offer a unitized structure that provides daily liquidity, lower fees and the same protections found in traditional mutual funds.

Despite alternatives’ rise in popularity, though, it’s still an unfamiliar asset class to many investors, especially those who are used to stocks and bonds. But now could be an ideal time to add alternatives to an investment portfolio, says Seychuk. “In this kind of environment, where equities continue to grind higher, why not consider adding asset classes that give a different return experience if stocks go south?”

Tap into more yield

There’s another benefit to owning alternatives: yield. Many of these investments generate decent incomes every year. For instance, toll roads and airports, two classic alternative examples, generate copious amounts of cash annually, and some of it is given back to investors. That’s attractive in a world where bond rates remain low. “Investors have looked to alternatives to enhance the yield in their portfolios,” says Seychuk.

Be aware of the risks

Of course, every investment comes with risk, and alternatives are no different. One of the main concerns has been around liquidity – it’s not easy for companies to sell a real estate holding or a private-company investment. Infrastructure or private-equity focused mutual funds and ETFs, which would hold a basket of publicly traded companies, have helped solve that issue for the average investor, but it’s still something to be mindful of.

Any one strategy will also experience its own ups and downs, even if it’s uncorrelated to the broader market. As always, diversification is a must. “When used correctly, alternatives can reduce portfolio risk, but they may increase risk if concentrated in a single strategy that on its own can be very volatile,” says Seychuk.

An advisor can help

“Because these investments are less familiar to many, we at Mackenzie Investments believe it’s imperative that investors work with advisors and other financial experts who understand the behaviours of these different asset classes and can build a portfolio that can help reduce overall risk,” says Seychuk.

Alternatives will play an even greater role in Canadian portfolios going forward, which is why advisors and investors must start thinking about ways to integrate these assets into their portfolios.

Seychuk’s advice? Think about the existing portfolio and one’s sources of return and risk. Then “identify asset classes that can reduce the portfolio’s correlation to equity risk or interest-rate risk,” he says, “but can make the overall portfolio better by offering the potential of more return.”

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