Individual investors may feel that they are at a disadvantage when investing in the financial markets as compared with institutional investors such as pension funds, insurance companies and the large mutual fund managers, and they are right in feeling this way. Institutional investors can access a broad and deep array of asset classes other than equities and bonds, called alternative assets that seem out of reach for individual investors. Not too long ago alternative investments were only the privy of very wealthy investors given that they are difficult to analyze and even harder to buy.
With the evolution of exchange traded funds and other specialized funds it is certainly possible today for individual investors (though still depending on particular circumstances such as their level of assets and access to specialized investment advice) to own a broader range of asset classes such as emerging market bonds, US mortgage backed securities, private debt, Canadian and US privately held real estate including agricultural land, US and European high yield bonds and leveraged loans, agricultural and industrial commodities and interest rate products.
This seems daunting. So, is there a reason for individual investors to consider these types of assets? Most certainly, given the current higher correlation between global equity markets, falling volatility (the volatility index is at an all time low just as stocks are at all time highs), expensive traditional fixed income securities and rising inflation. There is a very strong case for diversifying a typical portfolio holding traditional asset classes such as equities and fixed income. A survey of institutional investors showed that they have reduced their equity exposure from nearly 60% down to 50.0% over the last 15 years. Fixed income holdings declined to 26.0% but alternative assets have risen dramatically from under 10% to nearly 25%. Individual investors can look to creating a similar portfolio structure. Including alternative asset classes can be effective in an individual’s long term growth oriented portfolio.
Individual investors close to retirement, those with small portfolios or those that may need to liquidate assets in the near term should not consider alternative asset strategies. But investors with a longer term horizon should weight significantly towards equities and balanced out with preferred shares and alternative assets. Also, all categories of investors should avoid investing in leveraged products especially ETFs as these suffer from decaying returns over longer holding periods.