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Partner Insight: What benefits can alternatives offer in the current market?

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With the size of the alternative investments sector predicted to reach $14 trillion by 2023, we review which asset classes and strategies fall under the heading of alternatives - and what investors need to be aware of

Once seen as a niche market, alternative investments have become increasingly popular in recent years. In 2016, 344 new alternative funds were launched, compared to 10 in 1997. And further growth is on the horizon: a 2018 report by data tracker Prequin, The Future of Alternatives, predicts that the alternative investment industry will reach AUM of $14 trillion by 2023 - up from $8.8 trillion at the end of 2017.

Alternative strategies

As well as investments in assets such as real estate and infrastructure, Louis Tambe, Fund Analyst at FE, points out that alternative investments can also include hedged exposures in

traditional assets where the alternative return stream comes from difference in trading strategies. "Essentially any asset whose return drivers differ from equity or fixed income exposure can be considered alternative," he says.

Matias Möttölä, Associate Director, Multi-Asset and Alternatives at Morningstar, says that while alternatives can be defined according to the type of assets they invest in, such as real estate, timber or commodities, "this is not the definition we use in our products." Instead, he says that Morningstar's alternative categories consist of funds that use alternative or ‘hedge fund type' strategies in managing money.

"These funds typically go both long and short individual investments and even the market," he says. "They belong to categories such as long-short equity, market neutral equity or systematic futures, to name a few." He adds that the largest group of alternative investments are so-called multi-strategy funds, "which use several different types of strategies and typically want to reach an absolute return target, rather than trying to beat a market benchmark such as the FTSE stock index."

Characteristics of alternatives

While ‘alternatives' covers a diverse range of assets, they may have certain characteristics in common. A 2018 paper published by CAIA Association and the CFA Institute Research Foundation, Alternative Investments: A Primer for Investment Professionals, outlines three primary attributes of alternatives, any of which can lead an asset to be classified as ‘alternative':

1. Returns are driven by exposures to underlying assets with non-traditional cash flows - "that is, cash flows that are not highly correlated with those that underlie traditional stocks and bonds."

2. The returns of the investment are driven by complex trading strategies which result in "unusual risk exposures."

3. Returns are structured to "generate non-traditional payouts". The report notes that in all of these cases, specialised methods of analysis are needed as returns do not mimic the returns of traditional asset classes - i.e. stocks and bonds.

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