UniFi by CAIA Crossing the Threshold - 27

Today, the different flavors of alternative asset classes, strategies, and fund structures
are exceptionally broad and growing, and choosing the most appropriate ones can be
daunting. Understanding " the WHY " can simplify this task by narrowing down the options
to those that best align with the investor's financial goals. Knowledge of the investor's
financial circumstances and preferences can then help you determine the most suitable
means of accessing an alternative-whether through liquid, hybrid, or illiquid vehicles.
Lastly, a goals-based framework can help engage investors and keep them focused on their
goals rather than short-term market behavior. Communicating how alternatives contribute
to investor objectives and discussing performance in the context of goals instead of an
arbitrary benchmark can help strengthen the investor-advisor relationship.
The WHYs of Alternative Investments
Let's explore some common answers to the WHYs and how alternatives can play a
significant role within an investor's portfolio.
Diversification
One of the most common (and important) goals for investing in alternatives is
diversification of investment risk. While stocks and bonds serve as healthy
diversifiers over the long term, many alternative asset classes have
return drivers and risk characteristics that are different and are
less correlated to stocks and bonds. Such alternatives can be
among the most powerful diversifiers within a portfolio.
Real assets, such as direct real estate and private
infrastructure, commodities, such as gold, and
trading strategies such as managed futures and
long-short hedge funds have historically offset
equity and bond risk in traditional portfolios.
It is important to note that not all
alternatives are good diversifiers of
risk. Some alternatives, like certain kinds
of hedge funds and private equity may
have high potential for returns, but those
are accompanied by risk characteristics that
amplify, rather than mitigate equity risk. Those
alternatives may be best suited for growth-seeking
investors with greater risk capacity. You should look
closely at both the characteristics of the underlying
strategy as well as the fund structure to discern whether
the investment offers true diversification, especially during
challenging economic times. For example, a closed-end affordable
housing fund, a publicly traded REIT, and a private fund investing in
distressed commercial real estate will each have different return drivers
and correlations with stocks and bonds, despite all three being real estate
assets. Understanding these drivers will help you determine if and how they
contribute to achieving the investor's goals under different economic cycles.
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UniFi by CAIA Crossing the Threshold

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