Alternatives may provide the opportunity to improve a portfolio's diversification—measured by annualized standard deviation—historically reducing its volatility without sacrificing return.
Alternatives Have Fared Well Compared to Stocks
The Sharpe Ratio, a standard measure of risk-adjusted return, of alternatives is higher than stocks and comparable to bonds for the period 1999-2018.
Improved Diversification Through Low Correlation
Alternatives have historically moved in different directions than traditional asset classes. Generally speaking, the less correlation two investments exhibit, the greater the diversification they provide when combined in a portfolio.
|Stocks||Bonds||Alternatives||Alt Fund of Funds||High Yield Bonds|
|Alt Fund of Funds||0.716||-0.022||0.947||1.000|
|High Yield Bonds||0.683||0.194||0.661||0.565||1.000|
Data from January 1999-December 2018. Sources: Morningstar Direct and Hedge Fund Research (HFR). Stocks represented by MSCI World Index. Fixed Income represented by Barclays U.S. Aggregate Bond. Alternatives represented by HFRI Fund Weighted Composite Index. Alt Fund of Funds represented by HFRI Fund of Funds Composite Index. High Yield Bonds represented by Barclays U.S. High Yield Bond Index. Refer to the glossary for definitions of terms and indices.
Lower (and Variable) Beta Than Equities
While correlation is useful to illustrate the likelihood that two assets may move in the same direction at the same time, beta can help to gauge the magnitude of those movements. Beta is a measure of the sensitivity, or volatility, of one asset to the market as a whole. Alternatives have historically exhibited low beta to stocks and bonds and their returns have been less sensitive to market movement.
A look at the beta of alternatives over time shows that, on average, alternatives beta was 0.35 to stocks for the period since 1999.
More Consistent Return Pattern
Historically, the impact of this relatively low beta to stocks has been to smooth portfolio returns. In fact, alternatives have provided much of stocks’ upside with considerably less downside risk.
Potential Downside Protection
Alternative investments have historically shown more resilience during major market corrections.
When adding alternatives to a portfolio, the allocation source matters. These tips can help you determine where to reduce other allocations in favor of liquid alternatives.
Diversification does not assure a profit nor does it protect against loss of principal.
This information is for educational purposes only and is not intended as investment advice.