Alternative Investments: One Way to Manage Investment Risk

by Donald C. Schultz

Looking for a way to manage portfolio risk? Alternative investments may be a good choice.

An alternative investment is loosely defined as an investment in something other than publicly traded, long-only stocks, bonds or cash. Alternative investments are typically used to diversify an investor’s portfolio.

The alternative investment world is primarily made up of three buckets: real assets, private equity and hedge funds. Real assets could include things such as real estate, timber or infrastructure.  Private equity may include private equity funds and venture capital. Hedge funds can provide exposure to investment strategies that typically have less correlation to equity and fixed income markets.

But every investment has its own share of risk, and alternative investments are no exception. Some of the common risk factors include:

• Higher fees

• Diverse investment structure, from    registered mutual funds to    less regulated structures such as limited    partnerships

• Valuation risk – the value of the    investment may fluctuate

• Leverage risk – leverage can cut both     

   ways; in a good year it may enhance   

   returns, but it can also magnify losses

• Illiquidity risk – getting capital back is

   driven by the terms of the structure in

   which you have invested

Because of these characteristics, due diligence is necessary before buying alternative investments.

Alternative investments as part

of a portfolio

There are a number of ways to diversify a portfolio to reduce risk. These include owning stocks from different sectors, bonds from different issuers with different credit ratings and maturities, or a variety of both equity and fixed income investments.

Adding alternative investments to a portfolio is another way investors could reduce risk exposure. These investments are known as “non-correlated asset classes,” meaning they are less likely to experience the ups and downs of the stock, bond and cash markets.

Another option for investors may be investing in a mutual fund that holds alternative investments. This would provide diversification, as well as the professional management associated with any mutual fund.

Know the risks and seek advice

Alternative investments are not for every

investor, and it’s important to understand the risks and considerations before making a purchase. They are subject to different securities industry regulations, so due diligence is critical.

Seek the advice of a financial advisor before making decisions regarding the addition of alternative investments to your portfolio. They can provide guidance about investments that may be appropriate based on your individual circumstances, goals, risk tolerance and liquidity needs.

This article is provided by Donald Schultz, a Financial Advisor at RBC Wealth Management. The information included in this article is not intended to be used as the primary basis for making investment decisions. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance.

Investing in alternative investments may be speculative, illiquid and not suitable for all investors. They are intended for investors who meet certain criteria and are willing and able to bear the unique economic risks of the investment. Investors should consider whether such investments are suitable in the light of their individual financial situation.

RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.