Traditional investments like shares, bonds and cash need help. Riccardo Fontanella, head of technical marketing at Alexander Forbes Investments, says that investors are increasingly looking to alternative investments for absorbing shocks from their investment portfolios.
Meet Mr Market
In his book, The Intelligent Investor, Benjamin Graham describes the financial market as a grumpy, moody and often depressed person. One day he is happy with markets on the rise, the next day he is depressed and causing markets to fall through the floor. The problem is that one never knows in what mood he will be.
For many years, blending shares, bonds and cash in traditional investments has helped investors absorb the impacts of Mr Market’s fluctuating temperament and its impact on investment portfolios. Each asset class has different risks, responds differently to the same event and produces different returns over time. Blending these characteristics can help reduce overall investment risk, says Fontanella.
More recently, however, we have seen Mr Market becoming increasingly wild and irrational. The unexpected events that are responsible for making Mr Market feeling this way carry massive consequences for financial markets – they are fluctuating drastically beyond levels that traditional investments can withstand.
An oak tree and a reed – a story of strength and flexibility, or resilience and adaptability
There’s a fable about an oak tree and a reed. An oak had grown big and strong, rooted deeply into the ground, and it taunted the reed that lay below for its frailty and lack of size. One day, a violent storm came overhead. By the time the clouds cleared and winds calmed, it was the oak tree that had cracked and fallen over, its rigidity leaving it stretched across the centre of the meadow. And the reeds, which knew how to bend with the wind, were still in their place.
This story illustrates the importance of adapting to, rather than resisting or ignoring, some shifts we are experiencing in the investment landscape (and Mr Market’s temperament!).
Fontanella explains that the investment world has long been full of giant oaks – traditional investments such as shares, property, bonds and cash are solid and strong in their own right. “These asset classes are often considered a symbol of investment reliability. They are so deeply rooted into the portfolio composition of the average diversified portfolio that they seem indestructible.”
He adds, “We are living in a time where financial storms could become fiercer – heightened levels of uncertainty and fragile economies can bring about rapid market changes and greater, more frequent volatility than we’ve experienced over the last decade. The giant oaks of traditional investing are likely to face more strain, and investors will need help.”
Now seems like a time for investment strategies to explore their reach among the reeds, to seek out alternative assets that can withstand shocks to traditional capital markets.
Rather than standing firm when environments are shifting, investors need to make their investment portfolio resilient. Through alternative investments such as hedge funds and private market investments, they can embrace innovative opportunities in unexploited areas of the market. Resilience is about long-term strength, which means allocating to assets that bend sometimes, but that do not break.
“Without alternative assets in your portfolios, you won’t capture their investment returns and diversification benefits,” concludes Fontanella.