Alternative investments as part of a portfolio

Tom Britton -CTO & co-founder

Just how much of your portfolio should be in alternative investments?

While you, like many, might be stumped on what exactly an alternative investment is (feel free to immerse yourself at any point on our Alternative Investments page), for the purposes of this article all you need to know is that alternative investments are investments into asset classes other than stocks, bonds, and cash. Common examples include investments into art, wine, antiques, coins, or stamps and some non-traditional financial assets including commodities, private equity, distressed securities, hedge funds, venture capital and, most recently, equity crowdfunding.

Examples of Alternative Investments

Business Angels buy equity in or lend money to young companies that are often considered too risky for banks. Nesta reports that over a 10 year period, Business Angels averaged a 22% gross Internal Rate of Return (IRR). This is remarkable given that the vast majority of their investments fail, but profits from the star companies in a good portfolio far outweigh the losses of the many.

Wine has long been a source of not only enjoyment, but investment as well. In relation to returns, between 2003 and 2011 prices of the most sought-after wines rose by more than 250% (The Telegraph, August 2014). However, in the past two years they fell back by a fair bit, and someone who invested in a good portfolio 10 years ago would have returns of 150%:

Stock investors looking for an easy way to diversify often consider investing in a Hedge Fund which, managed by an experienced individual, will in turn invest in a diverse portfolio. Reports vary, but the majority seem to agree that hedge funds, as a class, haven’t delivered above-market after-fee returns for quite some time (Bloomberg May 2014).

The role of Equity Crowdfunding in Alternative Investments

While Alternative Investments have been around, and known by the investment community for a long time, it is the explosion of equity crowdfunding — thanks in part to the popularity of early stage investing TV shows like Dragons Den and Shark Tank — that has turned the public’s attention towards this investment type and sparked curiosity in even the most prudent of folk. And, while many are sitting up and starting to pay attention, there seems to be little understanding of just how much of one’s portfolio should go into these types of investments; particularly as they are often longer term, less liquid, and slightly riskier investments.

Expert’s opinions on Alternative Investments

Digging into the matter, we’ve discovered two authorities on the subject who both claim that 20% of a traditional portfolio should be invested into alternative investments. First, research from Robert W. Baird & Co. shows that “Replacing 20% of a traditional portfolio (invested 60% stocks and 40% in fixed income) with a broad mix of alternative products reduces volatility by approximately 10% and, after all fees and expenses are accounted for, slightly increases returns” (Do Alternative Investments Belong in Most Individuals’ Portfolios?Wall Street Journal May 13, 2014). Second, while speaking at the UK Business Angel Association Summit 2014, Nicola Horlick, Chair of Rockpool Investments LLP, reiterated her stance that 20% of one’s portfolio should go into Alternative Investments.

While these two seem to agree on a hard figure, the rest of the community vary greatly. For example, take a look recommendations, as a range, that come from just a few leading firms:

*source: Morningstar.com

There are of course a number of individuals who don’t believe alternatives belong in a portfolio. One of these naysayers is George Papadopoulos, a wealth manager at Novi. George sites his reasoning in the lack of Liquidity and Transparency that surrounds some types of Alternatives. Both of these points are valid for certain alternatives, so before considering to invest one should take a deep look at their investment requirements and ensure their portfolio can accommodate the potential risk and longer-term holding positions that may be required.

Ultimately, the decision comes down to the risk appetite of the investor. So, whether it’s 5% or over 50%, understand what you are getting into and be sure the rest of the portfolio can sustain any potential losses.

Interested in diversifying your portfolio, read more about Alternative Investments or Sign up and have a look at the Business Angel backed companies currently looking for investment on SyndicateRoom.

Originally published at www.syndicateroom.com.