As market volatility persists despite rebounding asset prices, advisors are rightly questioning the impact of diversification. Today, diversification must mean more than multiple asset classes, it also includes alternative investment strategies that until recently have been available only for high net worth investors.
Demand among advisors for alternative strategies has never been greater, and for good reason. Alternatives provide access to both non-traditional asset classes and "alternative beta." Alternative strategies seek to deliver non-correlated returns, thereby increasing portfolio diversification and dampening volatility. In addition, alternative portfolios use tools and strategies not available to long-only managers. This flexibility opens up the toolbox for skilled managers to potentially achieve a more attractive risk and return profile through the use of derivatives, leveraging, selling short, or just investing with a less constrained "style-box" focused approach.
One of the challenges with alternatives, however, is access. Typically, alternative strategies are structured as private partnerships that require investors to have an "accredited investor" status, come with high investment minimums, and include fees that can range between 1% and 2% of the fund's net asset value per year plus an incentive fee of as much as 20% of gains.
Additionally, many alternatives have lockup periods, making them illiquid investments. Finally, there is often little transparency into holdings, leading to difficulty in evaluating and understanding the portfolio's underlying risk.
