Placing a portion of your portfolio in alternative investments can offer several benefits not available to investors who take the more traditional approach of entrusting all of their wealth to stocks, bonds, and cash. Let’s discuss a couple of the biggest advantages of this investment strategy.
Ironically, many investors become interested in allocating some of their capital to alternative investments for the same reason touted by advocates of investing exclusively in the debt and equities markets: diversification. We at Worcester Investments believe, however, that the stock-market advocates’ strategy for diversifying your portfolio is incomplete. Here’s why.
The conventional investment approach, advocated by most financial advisors and (for obvious reasons) stock brokers is to place a certain portion of your capital in stocks and the remaining portion in bonds. The Motley Fool explains on its website, for example, that these two types of assets should generally make up 100% of an investors’ portfolio, with younger investors placing a greater percentage in stocks and then shifting more into bonds as they get older.
Interestingly, though, you can find another entry on The Motley Fool’s site explaining that stocks and bonds tend to move in the same direction. We’ve seen an exception to this rule of thumb in the recent post-crisis years, where they’ve moved in opposite directions. But historically speaking if the stock market is performing poorly, the bond market will likely be experiencing a downturn as well.
So ask yourself: If you are invested entirely in a combination of debt (bonds) and equity assets (stocks or mutual funds), are you truly diversified?
To diversify your portfolio, you’ll need to do more than simply spread your stock picks across several industries. You will also need to allocate some of your money for asset classes entirely outside the financial markets—such as real estate.
One of the biggest advantages of investing in an alternative asset class like real estate is that it tends to have a low correlation with the stock market. Private equity real estate funds, for example, tend to perform according to the strength of the properties under their management and the health of the broader real estate market. In other words, they don’t tend to be carried along for the volatile rides of the financial markets.
Another benefit of alternative investments is their potential strength as a hedge against inflation. Stocks also tend to offer some long-term (although not short-term) inflationary protection. But if inflation rises sharply, stocks prices can fall as investors grow nervous about what those rapidly rising prices suggest about the economy’s health, and as those publicly traded companies’ revenues fall because consumers pull back on spending.
Some alternative investments, on the other hand, can provide investors stronger inflation hedges even as prices rise sharply. For example, let’s consider private equity real estate again. Because the operating costs of the properties in a real estate fund’s portfolio are often fixed for a long term—particularly the mortgages—these investments are less likely to be harmed directly by inflationary pressures.
As evidence of this, let’s look at a recent long-term study by CBRE Econometric Advisors. Their research found that during the nearly 40 years from 1978 through 2016, both retail and multifamily properties have served as complete hedges against inflation for their investors.
One important caveat: Alternative investments can also refer to different types of hard, tangible assets other than commercial property, such as precious metals or high-end collectibles like art and rare coins. These hard assets, too, can serve as long-term hedges against inflation. But it’s important to keep in mind that unlike commercial property, a stash of gold bullion or high-end paintings and sculptures will probably not be able to produce income while the investor holds it.
This is one reason commercial real estate can be among the best alternative investments: It can help protect your wealth against inflation over the long run, and in the meantime it can also produce ongoing income.
One obstacle historically preventing many investors from reaping the benefits of alternative investments was their high price. If you wanted to invest in a piece of commercial real estate, you needed to raise many hundreds of thousands or even millions of dollars.
Moreover, placing all of the capital you allocated for an alternative investment into a single property would seem to undermine the diversification strategy. Yes, setting aside some money for a hard asset like real estate would help you lessen your exposure to the risks of the financial markets, but investing all of that capital to buy a single property created its own diversification problems.
This is why we believe a smart strategy for alternative investing is to participate in a private equity real estate fund. Such a fund can protect you both from the volatility of the stock market and the coming inflation—not to mention the headaches of directly owning and managing a piece of commercial real estate.
Let us introduce you to The Worcester Fund from Worcester Investments, the trusted name in Kansas City multifamily real estate.