Alternative Strategies in Challenging Markets

By Cleo Chang - February 16, 2018

Last week's equities sell-off is likely a healthy adjustment to an otherwise persistent bull market. Yet, it also serves as a reminder that investing is inherently a risky business, despite the relative complacency of 2017.

Traditionally, investors relied on bonds to provide a level of diversification that seeks to manage the risks of severe equity moves. However, we believe fixed income is not likely to provide the same level of risk management it may have provided in the past. Concerns about rising rates, a reduced Federal Reserve balance sheet and the impact of tax reform are all fueling a synchronized pullback, with the Barclays Universal Index falling close to 2% so far this year.

We believe markets will continue to wrestle with these challenges for the next few months. As such, alternative investments may serve as a complementary addition for investors looking to diversify their portfolios beyond stocks and bonds.

Alternative Strategies

Alternative investments vary in terms of their strategies and risk profiles. Generally, they are designed to help investors pursue their investment objectives by seeking to deliver attractive risk-adjusted returns less sensitive to rising interest rates and drops in stock prices.

They do this by holding a variety of non-traditional investments, often employing more complex trading strategies than traditional funds. Each strategy can have unique risks and are thus more suitable for investors who take the time to fully understand the assets, strategies and risks before investing.

Below are three major types of alternative investment strategies based on how they are designed to help investors aim for specific investment objectives.

Objective: Build Wealth While Minimizing the Impact of Down Markets

Directionally oriented strategies, such as long/short equity strategies, tend to follow the markets more closely with a net long exposure to stocks. This allows them to benefit from equity performance when markets are going up. Unlike straight equity funds, however, long/short strategies also carry sizable short positions, which seek to capture gains when stock prices fall. As a result, these strategies may help minimize downside losses.

Objective: Generate and Preserve Income

Alternative income investment strategies aim to opportunistically invest across a broad range of income sources such as securitized debt, emerging market debt, real estate investment trusts (REITs) and high-dividend stocks (among others). Generally, as interest rates rise, bond values decline, and vice versa. A diversified mix of income sources can be less correlated with traditional bonds, which may help potentially offset the effects rising interest rates on a fixed income portfolio. In addition, these types of strategies may also use methods like shorting to try to capture gains in down markets.

Objective: Hedge Against and/or Profit from Down Markets

Equity market neutral strategies maintain an equal allocation to both long and short stock positions. These portfolios seek to generate returns regardless of market direction. Because these strategies often have a low or negative correlation to equity and fixed income markets, they are often used as an attempt to manage volatility and the impact of severe market swings.

Addressing Market Challenges

Growing capital, generating income and protecting gains—we believe alternative investments can meet multiple investor goals. In today's challenging markets, it's worth considering. As with any strategy that aims to hedge against market risk, alternatives tend to do better than stocks in down markets, but can lag performance in strongly trending up markets, such as the 2017 bull market. Therefore, alternatives should be considered as a complementary component to a diversified portfolio, rather than a stand-alone investment.

Cleo Chang
Cleo Chang

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Learn more about alternative investments in light of current market volatility.

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      Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.

      Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

      Diversification does not assure a profit nor does it protect against loss of principal.

      Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.