We believe that the addition of a new alternative investment to a well-diversified traditional portfolio, when actively managed, can significantly enhance the benefits of diversification. By incorporating alternative assets into a portfolio, the risk-return profile can be improved compared to a benchmark portfolio consisting solely of mega-cap stocks and bonds.
One of the primary advantages of including alternative assets in a portfolio is the potential for lower risk at a given level of return. Alternative investments, such as cryptocurrencies, real estate, commodities, or private equity, tend to have lower correlations with traditional assets like stocks and bonds. This low correlation means that their performance is less influenced by the movements of the broader market. As a result, when combined with traditional assets, alternative investments can help reduce the overall portfolio risk.
Diversification is a cornerstone of portfolio construction as it allows investors to allocate capital in a manner that limits exposure to the risk of individual assets. By spreading investments across various asset classes with low correlations, investors can mitigate unsystematic risk, which is specific to individual assets or sectors. The rationale behind this risk management strategy is that a well-diversified portfolio consisting of low-correlated assets has the potential to generate a higher long-term return while reducing the impact of unsystematic risk.
Moreover, incorporating low-correlated assets in a portfolio serves as an efficient hedge against market volatility. During periods of market turbulence or economic downturns, different asset classes may react differently to the prevailing conditions. By holding assets that have historically demonstrated low correlations with one another, the portfolio is better positioned to withstand market fluctuations and provide stability in the face of volatility.
Additionally, the inclusion of alternative assets in a portfolio can offer the potential for higher long-term returns. While alternative investments may exhibit higher volatility in the short term, they often provide opportunities for enhanced returns over an extended period. These investments can tap into unique market trends, sectors, or strategies that are not readily available through traditional investments. By diversifying into these alternative assets, investors can access new growth opportunities and potentially capture higher returns over the long term.
It is important to note that actively managing the alternative investments within the portfolio is crucial. The dynamic and evolving nature of alternative assets requires ongoing analysis, monitoring, and adjustment to optimize their performance and manage risks effectively. Active management ensures that the portfolio remains aligned with the investor’s objectives, risk tolerance, and market conditions.
In conclusion, the addition of alternative investments to a well-diversified traditional portfolio has the potential to enhance diversification benefits, lower risk, and provide higher returns over the long term. By incorporating assets with low correlations to traditional stocks and bonds, investors can mitigate unsystematic risk, hedge against market volatility, and tap into unique market opportunities. However, active management of the portfolio is essential to ensure optimal performance and alignment with the investor’s goals.
“Substantial allocations to traditional and alternative assets offer a level of diversification unavailable to unaccredited investors, allowing the creation of portfolios with superior risk and return characteristics”
Victor R. Ch. Rollman, CEO and Co-Founder
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