The Role of Alternative Assets in Portfolios

For high-net-worth (HNW) Canadians, alternative assets can enhance portfolio diversification, help reduce volatility and unlock opportunities for attractive returns. Alternatives differ from traditional investments such as stocks, bonds and cash by providing access to unique assets, markets and strategies and can be global in scope.

A Wide Range of Investment Possibilities

Examples include real assets (including infrastructure, commercial real estate, timber and farmland) private equity and private credit. Hedge funds using leverage, long/short strategies and derivatives are another example, as are niche categories like art and fine wine. While once available only to institutional investors, qualified individual investors can gain access through focused investment vehicles or investment products holding multiple types of alternative assets.

The objective is typically to exploit certain risk-return characteristics of the targeted asset(s), which are usually different, to varying degrees, from publicly traded stocks and bonds. In addition to seeking enhanced levels of return, another key goal can be to potentially generate returns when traditional markets are declining. For example, a toll highway or commercial building can continue generating fees and rents when equity markets are volatile.

Alternatives are not suitable for every investor but can be a beneficial addition to a well-diversified HNW portfolio. It is important to understand the underlying investments and potential risks. Your personal investment time horizon, risk tolerance and liquidity needs should be carefully considered because, unlike stocks, some alternatives cannot be sold on short notice. Your advisor can review these and other key factors with you and provide suggestions that can complement your current holdings.

Popular Alternative Investments

• Private equity usually invests in companies that are not publicly traded. This can range from well established firms to startups and growth-stage businesses. The global private equity market is estimated to exceed USD $7 trillion. The goal is to participate in growth through an ownership stake and then exit via a public offering or sale to other private equity investors.

  
  

• Private credit is financing for businesses provided by non-bank lenders. Similar to private equity, HNW investors can access this asset class directly through dedicated strategies or indirectly via pooled funds investing in private credit lenders. Private credit can often generate better yields than publicly traded bonds, making it an attractive addition to traditional fixed income portfolios.

  
  

• Real assets include REITs, infrastructure (toll highways and bridges, utilities, renewable energy, transportation, ports, airports) farmland and timber holdings that deliver revenue streams plus capital appreciation potential. The investment focus is usually on core, income producing assets.

  
  

• Hedge funds pool money from institutions and wealthy individuals to invest in a variety of financial assets, including, but not limited to, traditional stocks and bonds, with the goal of generating high returns, regardless of market conditions. A key feature is the use of various strategies to exploit market opportunities and inefficiencies, including long and short positions, leverage, derivatives, and arbitrage

  
  

• Commodities such as precious metals, oil and agricultural products can further diversify HNW portfolios and act as inflation hedges.

  
  

• Collectibles and art such as rare coins, vintage wine and fine art can offer long-term appreciation potential and low to no correlation to traditional investments. Like all alternative investing, this niche requires specialized expertise in what can be relatively illiquid markets.

Important Benefits

1. Diversification:

Alternatives can help manage overall portfolio risk by increasing and/or spreading investment exposure to assets with low or even no correlation to traditional stocks and bonds. Depending on the actual strategy, alternatives can offer protection against periods of broader market volatility and economic downturns.

2. Access to growth:

New, high-growth companies and industries often tap private markets for capital to drive rapid expansion. These opportunities are unavailable to most investors but HNW individuals can access them through private equity and credit strategies.

3. Capturing overlooked potential:

Private, illiquid or inefficient markets can contain hidden opportunities because investor awareness and research of them is far more limited than for publicly traded companies. Alternative strategies rooted in specialized knowledge and expertise in specific sectors can uncover potential others may miss.

4. Income generation:

Real assets can provide steady cash flows through tolls, fees, rent, dividends and project returns. These investments can complement and diversify traditional fixed income allocations, particularly in lower yield environments.

5. Inflation hedging:

Alternative assets such as real estate, infrastructure, and commodities can act as hedges as the values of these types of assets tend to keep pace with inflation.

6. Tailored risk-return profiles:

The scale and variety of the alternative investment universe means there are many options for finding ones that align with your personal risk tolerance, time horizon, and goals.

7. Wealth preservation:

Alternative investing can support objectives to protect  and increase multi-generational family wealth over time  while providing some insulation from volatile periods in  public markets.

Key Factors to Consider

1. Eligibility:

Canadian regulations typically restrict alternative investments to institutions and accredited individual investors with minimum net worth thresholds.

2. Illiquidity:

Many, but not all, alternative investments require a long-term commitment and may not be easily liquidated. This should be weighed against your own near and mid term requirements.

3. Fees:

Due to the highly specialized knowledge and expertise required to manage alternative strategies management fees can be higher, on average, than for traditional asset classes.

4. Complexity:

The strategies used in many alternative investments can be complex. Work with your advisor to fully inform yourself about the suitability of any potential investment for your personal situation.

Conclusion

For HNW Canadians, alternative assets can be a valuable addition to a well-rounded investment strategy and help stabilize portfolios in periods of volatility in traditional markets. In many cases the attributes of alternatives can provide you with access to unique opportunities for growing and preserving your wealth. However, the complexity and specific risk characteristics of alternative strategies require due diligence, expert advice, and alignment with your personal financial goals and time horizon to be successfully integrated into a broader investment portfolio. 

You can begin your research today by asking your advisor for more information.