Alternative investments have become a bit of a buzzword in the investment industry, a hook for investors looking to stave off risks with some so-called out-of-the-box thinking.
But according to Bryan Mullin, head of alternative investments at RBC Wealth Management-U.S., alternative investments aren't really that out-of-the-box when it comes to their basic details.
“Alternatives are just stocks and bonds put together with different legal wrappers and with a more active strategy,” says Mullin.
The investments still provide exposure to the three base asset classes – equities, fixed income and real assets (things like commodities, real estate, and infrastructure) – the same type of things you most likely already hold in your investment portfolio. But it's the structures and strategies used that really define the alternative investments category, explains Mullin.
“This is where Wall Street has crossed with innovation,” he says.
And it's that innovation element that has a tendency to lead to miseducation and confusion around alternative investments.
According to data from The Economist Intelligence Unit (EIU), commissioned by RBC Wealth Management, 72 percent of respondents in the U.S. agree that today's global markets require investors to be far more flexible and responsive in their investment strategies.
The New wealth rising survey, which target both high-net-worth individuals (HNWIs) and their children, along with high-earning professionals, across the U.S., Canada, UK, Hong Kong, Singapore and Taiwan, also found 60 percent of investors in the U.S. expect a financial advisor to offer unique investing opportunities.
What is an alternative investment?
Alternative investments are an ever-evolving category with new strategies cropping up to reap the benefit of inefficiencies in the market. But from a top-down level, the investments can be broken down into those three principal categories: equity, fixed income and real assets.
Rather than contributing and taking distributions from a mutual fund, alternatives are often labeled hedge funds or private equity funds – both pools of accredited investors but each with their own quirks.
“Hedge funds tend to offer you at least some liquidity; they're not liquid on a daily basis, but you can decide when you want to ask for your money back,” says Leif Gunderson, product manager for alternative investments at RBC Wealth Management-U.S.
Hedge funds tend to invest in listed securities, Gunderson explains – things you could go and buy on the stock market. “There's just a different risk-return profile to hedge funds,” he adds.
Hedge funds, says Gunderson, are looking to benefit from inefficiencies in the actively traded markets. For example, maybe a particular hedge fund has identified a niche type of bond structure they can buy cheap and hold until it's worth more. Or maybe they're making short plays where they're selling a security in anticipation of a drop in price and planning to buy it back at a lower price.
Private equity, on the other hand, plays by its own set of rules.
“On the private capital side, the key delineation is you can't ask for your money back,” Gunderson says. “You make a commitment to a fund and they will invest it over time as they find opportunities.”