The term ‘Alternative Asset Class’, or ‘alternatives’ is a loose one which can potentially include any investment outside the traditional categories of equities, property, bonds and cash. However when Mercer uses the term, we use it to denote an investment strategy or a collection of investment strategies that exhibit the following characteristics:
- They target meaningful growth significantly ahead of cash or government bond returns.
- They aim for low correlation with equity markets, i.e. there should be potential for them to deliver growth when equity markets do not perform.
- They target significantly lower volatility than displayed by equity markets.
The last point above effectively rules out certain higher volatility asset classes that sometimes carry the label ‘alternative’ elsewhere, such as emerging markets equities or commodities.
Advantages of alternative asset classes
- Because of their significant growth targets and their low correlation with equity markets, alternatives can provide an excellent method for reducing risk within a portfolio while still maintaining high growth potential.
- In periods when equity markets fall, alternative asset classes may reduce the level of overall losses suffered.
The disadvantages of alternative asset classes are:
- They are typically complex and difficult to understand.
- The charges can be higher than for standard managed funds or equity funds.
- There is no guarantee that alternative asset classes will deliver growth.
- Growth in the long run tends to be lower than for equities.
Mercer's view on alternatives
Mercer believes that alternative asset classes can form a valuable part of a low-medium, medium, medium-high or high risk portfolio as a means of dampening volatility without compromising too much on growth. However for most portfolios, more traditional asset classes such as equities, bonds or cash should probably form the core.
The ‘Absolute Returns’ label
Many investment companies provide access to funds that they call ‘absolute return funds’. Some of these are, in Mercer’s view, excellent funds, as they exhibit the advantages described above. However the term ’absolute return’ is misleading, because very rarely do these funds absolutely guarantee returns of any kind.
Low risk investors should generally consider cash, government bonds or capital protected investments ahead of alternative asset classes or absolute return funds.