Lets Talk About Alternative Investment Strategies
Understanding alternative investments
In an ever-evolving and increasingly complex market environment, investors are actively seeking out opportunities to diversify their sources of return away from traditional equity and fixed income investments.
Alternative investments can be fundamental building blocks for a well-constructed portfolio and key components in helping investors achieve their goals.
However, because of the wide spectrum of approaches, differing objectives and varying levels of risk within each category of liquid alternative funds, investors should carefully research their investment options, and understand the unique objective and strategy of each fund to ensure they achieve the outcome they are looking for.
Key components of alternative strategies
To increase return or decrease risk, many managers of alternative strategies obtain leverage through the use of derivatives or short-selling.
A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset or set of assets. Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes and stocks.
Derivatives are an important component of alternative strategies as managers can use derivatives to create investment opportunities that would otherwise be unavailable to them as well as obtaining leverage and reducing transaction costs. Options, futures, forwards and swaps are all commonly used by Liquid Alt managers, depending on the strategy and constraints.
“Short-selling” is when an investor borrows securities and immediately sells them in the market, hoping to buy them back at a later time at a lower price, retaining the difference in price as profit. This action allows the investor to benefit from a decline in the security’s price but can also result in losses if the price increases beyond the original purchase price. Short-selling has significant risk associated with it because if the borrowed security’s price increases, losses can theoretically be unlimited.
Investors must also consider additional costs that will reduce their profit including interest owed on the securities loan, accrued daily and paid monthly.
Common alternative investment strategies
There are several different kinds of alternative strategies – here are a few of the most common:
These strategies take both long and short positions while maintaining overall long exposure in the portfolio. The objective of these strategies is to profit from price appreciation from long securities and price declines from short securities.
These strategies take both long and short positions in equal weights, in an effort to reduce or eliminate exposure to systematic risk so that returns are unrelated to those of the overall stock market.
These strategies involve taking long or short positions in global equity, fixed income, currency or commodity markets using derivative products including futures, forwards, options or swaps. Managed futures strategies often follow market trends or signals, for example price momentum.
These strategies combine a portfolio of different alternative strategies, such as long/short, market neutral and managed futures, in one portfolio. The fund manager can decide which percentage of capital to allocate among individual strategies in order to meet investment objectives.