Steep losses from the market meltdown of 2008 and 2009 have many financial advisors recommending that investors consider alternative investments. But what are these so-called alternatives and how do they fit into a portfolio?
Alternatives, in general investing terms, comprise portfolios that hedge their positions, invest in commodities through futures contracts or even trade currencies.
These portfolios may take long positions, which involve buying a security in the hope it will increase in value, or short positions, which involve selling a borrowed security in the hope it will decrease in value and can be purchased and returned to the lender at a lower price.
These strategies have long been used by institutional investors but are now available to retail investors through mutual funds and exchange-traded funds (ETFs) – and they’re increasing in popularity. A survey by investment firm Rydex/SGI found that 71% of financial advisors advocate alternative investments, and 19% already have at least half of their clients using them.
The potential benefit? Alternatives may have a low correlation to traditional investments like stocks and bonds, and that can increase diversification potential. Although diversification cannot ensure a profit or protect against a loss, more than 75% of financial advisors surveyed by Rydex/SGI said the primary reason they use alternative investments is to further diversify their clients’ portfolios.
But alternative investments aren’t for everyone. The performance of alternative mutual funds and ETFs can vary as widely as their strategies.
You may want to consider if alternatives are right for you. However, it’s wise to consult your financial advisor before jumping in. You may already have some exposure to alternatives, because traditional mutual fund managers might invest more in companies that benefit from rising commodity prices when commodity prices rise.