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Do Alternative Assets Add Value?

January 25, 2022

Alternative assets have gained popularity with investors in recent years. These types of assets include precious metals, natural resources, real estate, fine art, and collectables, among others.  Compared with traditional asset classes such as common equity and fixed income, proponents of alternative assets believe they can add diversification and reduce risk in well managed portfolios.

Some alternative investments may add value, but there are several potential drawbacks and increased risks for investors looking to allocate money into these assets. Liquidity risk is a major concern with alternative assets. Most common stocks, bonds, and mutual funds are easily convertible to cash. Alternatives, on the other hand, can take months or years to sell and may have a very limited pool of potential buyers. Management fees on alternative assets also tend to be higher than those of traditional assets. Additional performance fees may be levied if a manager exceeds a stated benchmark.  One may ask, with these risks, does it make sense to invest in alternative assets. Unfortunately, there is no easy answer. Some have undoubtedly done extremely well by investing in alternatives. Many investors may not benefit from these assets being added to their portfolios, as higher fees can quickly dilute returns. Over the long-run there is evidence that traditional asset classes may add more value.

Our view is that ample diversification can be achieved without the need for allocation to alternative investments. Many of the same asset classes within the alternative space can be accessed through traditional investment into common stocks. Real Estate Investment Trusts, Energy, and Materials are sectors within the equity market and include individual companies that have direct and indirect exposure to real estate, natural resources, and precious metals. Buying alternatives in addition to common stocks within these sectors could unintentionally add risk to a portfolio by overexposing these volatile industries.    

To use an analogy, a well-constructed portfolio can be thought of as a well-prepared meal. The “equity portion” of steak, potatoes, and dessert may taste the best but can be harmful when eaten excessively. The “fixed income portion” of fruit and vegetables may not be as delicious, but completes the meal with a healthy balance of nutrients. In our opinion, alternative assets are the unnecessary added sugar that provides a short-term boost of energy which may not be sustainable over the long-run.

Written by Jason Clevenger, CFA - Iowa State Bank VP, Trust Investment Manager