What is driving the interest in alternative investments and what are the best alternative investments? Whoa! Let’s slow down a bit and start with an alternative investments definition.
According to Investopedia. “An alternative investment is a financial asset that does not fit into the conventional categories of equity, income, or cash”.
So, if we are not talking about stocks, bonds, or cash investments… what is an alternative investment? Think of tangible assets such as real estate, collectibles like wine, art, and antiques; natural resources such as commodities, farmland, and forests; or financial assets such as venture capital, private equity, and hedge funds.
Many Investors are Tired of Hair-Raising Market Volatility
One of the reasons why alternative investments have become so popular recently is a general weariness brought on by the record-breaking volatility levels of 2022. Despite the global impact of COVID-19, the instability was not even across all industries. Businesses in the transportation, travel and leisure, and apparel sectors were far more affected than those in healthcare and telecom, for example. With alternatives investors can take short positions, allowing you to profit when prices decline.
Alternative investments have low correlation with the traditional public markets. Because alternative investments are less exposed to broad market indices, the influence of market volatility is lower. Well-known examples of alternatives, gold and silver, maintain their value and are generally uncorrelated with stocks. Similarly, North American farmland is uncorrelated with most asset classes and has held its value well in volatile times.
Since some alternatives act as hedges to traditional investments, and others can have risks that are totally uncorrelated to traditional market risks, including them in your portfolio can improve global risk-adjusted returns. Capitalists appreciate that increasing portfolio diversification with alts helps to reduce overall volatility.
Equities Remain Expensive, and Forecasted Future Returns Look Less Appealing
In North America, the U.S. stock market remains expensive with record highs for the three major stock indices and an S&P 500’s P/E ratio exceeding historical averages.
While the Buffett Indicator, calculated by dividing the total market cap of stocks by the GDP, measures the U.S. stock market as significantly overvalued, the Canadian stock market is only modestly overvalued.
Added to that is a growing pessimism about impending stock market returns. Analysts forecast declining stock returns in the United States. While this may not impact Canadian markets, one of the key success factors is a diversified portfolio.
Even with more normal TSX returns expected in 2022, an inflationary environment persists. Alternative investments like real estate, gold, or oil real estate can be used to effectively hedge against inflation risk.
Low Interest Rates are Depressing Returns
Many traditionally safe investments like company and government bonds are yielding below inflation returns thanks to low interest rates. Even taking into consideration the Bank of Canada’s June, 1st increase of 0.5%.
Given that alternatives involve a higher level of risk, they also have the potential for higher returns. When considering an alt portfolio, real estate is a category that offers many of the advantages of traditional investments, with promising returns.
No wonder long-term investors are therefore increasingly turning to the historically attractive returns provided by alternative investments.
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This commentary is provided for general informational purposes only and does not constitute financial, investment, tax, legal, or accounting advice. Please speak with your accountant about tax or accounting advice. Individual circumstances and current events are critical to sound investment planning and not all investments are suitable. Please speak with your investment advisor prior to investing.