The potential of alternative investments

Rafael Hurtado. Professor. IE Business School

19 December 2012

Low interest rates, the proliferation of investment vehicles and the rise of sovereign funds, are all paving the way for a promising future for alternative investments.

Not only have alternative investments grown extremely rapidly over the last fifteen years, but they also have enormous potential to continue to do so. The reasons for this potential are many and diverse. First, many institutional investors, such as pension firms or insurance companies, are seeking to improve their profit:risk ratio. The strategy most commonly used to achieve this is that of acquiring assets with little correlation to each other, given that the volatility of a portfolio is not the sum of the volatility levels of its components.

Hence, alternative investments, such as raw materials, venture capital or  hedge funds, generate, or could generate, a great deal of value given that they tend to have little correlation with traditional variable and fixed income markets. There are a large number of academic studies that show how to introduce alternative investments in mixed portfolios made up of shares and bonds to achieve greater efficiency, that is to say, to generate more profit per risk unit, or reduce the risk for the same level of profitability.

But the search for diversification is not the only reason. For example, the current monetary policy in the US and Europe has drastically lowered short-term interest rates, which has led many investors to seek other assets that can bring higher returns.

Another very important factor that is fuelling the growth in alternative investments is the large quantity of vehicles or tools that have been created to enable access to this type of strategy for ever growing numbers of investors. These now include minority investors, whereas before alternative investments were only used by institutions or other sources of vast wealth.

One example of the kind of tools that provide access to alternative investment are Exchange Traded Funds (ETF) linked to raw materials. Thanks to ETFs, any investor with even the barest knowledge of how the stock exchange operates can now invest in copper, gold or sugar. With regard to hedge funds, it is worth noting that since the beginning of the crisis, a large number of hedge fund managers have launched regulated funds for retail clients in OCDE countries which use strategies very similar to hedge funds. It is one way to be able to actively sell these particular alternative investments to all types of investors.

In conclusion, investors will continue to seek assets that diversify their portfolio away from traditional shares and bonds. It is foreseeable that tools that provide access to alternative investments will continue to emerge, and that institutions will gradually increase their exposure to said assets. This makes it highly likely that management of assets using alternative investment is set to rise. Moreover, there are new clients for these assets, like, for example, sovereign funds, which manage money from regions or countries with budget surpluses. My personal opinion is that the future of alternative investments looks promising.
El País Via@iebusiness November 27 2012

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