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Alternative Investments: Investing in Alternatives

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By definition, an investor interested in alternative asset classes is an investor who thinks about risk. This is not to say that these investors neglect the return side of the equation. Far from it. The goal of all investors is to maximise the return generated by a portfolio for a given level of risk, over a particular time horizon.

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In investment terms, this is called portfolio optimisation and is achieved by actively managing the risk and reward characteristics of the investments made. As we have seen in earlier topics, an optimal portfolio will be well diversified, combining asset classes that are uncorrelated to each other.

Alternative investments fit well into this diversification process.

  • Firstly, they represent an asset class of funds and products with greatly differing risk/return profiles.   
  • Secondly, they have little correlation to each other or to the financial markets.

In other words, alternative strategies provide a wide palette for investors who want to manage the levels of risk and return within their portfolios actively.

Whether an investor opts to put all of their capital into alternative investments, or only a part of it, they will need some basic tools for judging one fund or product against another.

Risk-adjusted return statistics are the most common metrics used to compare one alternative investment product with another. The most widely used risk-adjusted return statistic is the Sharpe ratio.

       

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