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Beyond stocks and bonds: Diversify your portfolio with alternative investments
Are traditional stocks and bonds all you need in your portfolio? For a growing number of investors, the answer is no. Although equities and fixed income can often be the foundation of any diversified investment strategy, some investors are adding alternative investment strategies and assets to minimize volatility and manage risk. So, what do you need to know about alternatives and how they can complement a traditional portfolio?
More accessible alternatives
Many investors still think of alternatives as something reserved for an exclusive few, like those who invest in hedge funds or spend millions on private real estate or collectibles like art and wine.
But that’s no longer the case. The world of alternative investments is far more accessible than you might expect. Although alternatives were formerly reserved for institutional and high net worth investors, because of high minimum investment requirements, recent regulatory changes have made them available to “do it yourself” investors through mutual funds and exchange-traded funds (ETFs). Here is a look at the types of alternatives you may be able to add to your portfolio.
- Liquid alternatives: These investments are one of the more accessible alternatives available to investors. These investments try to deliver returns that are less correlated with traditional asset classes, while still relying on the public markets. That makes them highly liquid and accessible, while still offering low minimum investment thresholds and strong regulatory oversight. To deliver uncorrelated returns, mutual funds, such as the ones Fidelity offers, may use strategies commonly employed by hedge funds, including short-selling, leveraging (borrowing money) or derivatives.
- Private equity: Instead of investing in a public company trading on the stock market, investors can buy shares in a private company. Typically, this type of investment is done through venture capital (VC), which focuses on early-stage startups, or through buyout firms that aim to deliver capital appreciation over the long term. These strategies, however, tend to be more accessible to high net worth (HNW) and institutional investors.
- Private credit: Publicly traded bonds are usually developed by financial institutions and then broken up into pieces and sold to investors. Private credit skips the banks and lends directly to a company with increased flexibility when negotiating terms. These private loans may not be as liquid as their publicly traded counterparts, but they can have comparatively higher yields, typically with longer holdings periods. Like private equity, these strategies tend to cater more to HNW and institutional investors.
- Cryptocurrencies: It can be hard to ignore the hype around the rising value of digital assets. Holding a small portion of crypto in your portfolio may help boost returns, but it’s important to remember that crypto can’t be held directly in registered accounts and all gains will be subject to capital gains tax. Investing in a mutual fund or exchange traded fund (ETF) like the Fidelity Advantage Bitcoin ETF Fund or Fidelity Advantage Ether ETF Fund™ allows you to hold them in a number of registered accounts, for example the TFSA, RRSP, RRIF, RESP and FHSA. Investing in crypto in a registered account offers investors tax advantages as opposed to holding it on a digital wallet or exchange platform.
- Real estate: Anyone who’s played Monopoly knows how real estate can build wealth. Gaining exposure to real estate in your portfolio can help you do the same, but you don’t have to own buildings outright. Real estate investment trusts (REITs) allow individuals to invest in the real estate market and earn income without having to own physical property. Investing in infrastructure funds that own physical assets, such as roads, airports, and utilities, is another option. These funds can provide stable cash flows through dividends, as well as long-term growth potential.
A balance of rewards and risks
Apart from potentially adding diversification, another upside of some of these investments is the prospect of achieving benchmark-beating returns.
Reward and risk go hand in hand, though. Alternatives are often complex, and they’re sometimes less regulated. The ones that aren’t in a mutual fund or ETF structure are also often illiquid assets, meaning they can be difficult to sell or exchange for cash. That lack of liquidity means alternatives aren’t for everyone. Ask yourself; Is the investment liquid? Will I be charged a penalty if I sell before a certain period? If retirement is decades away, alternative investments might yield more benefits over the long term compared with lower-risk traditional assets like bonds. Luckily its easier for investors to access alternatives in familiar products like mutual funds and exchange traded funds (ETF) that are liquid and have similar fees to traditional funds.
Alternatives may be newer to the investor, but they’ve been used for decades by institutional investors to enhance their portfolios and drive returns. Diversification with alternative investments can’t eliminate risk, but it can bring more stability to a portfolio in the long term and might even help boost its overall value.
Fidelity offers a variety of liquid alternative strategies designed to complement a traditional portfolio of stocks and bonds. These investment options can act as another tool to help achieve further diversification or work towards a long-term financial goal. We also have several product offerings that invest in alternative strategies for you. To find out more about which funds have exposure to alternative strategies or asset classes, talk to your advisor.