Introduction To Alternatives (Part 2)

This is a continuation from Part 1. In this post, I shall share with you on how to incorporate alternatives into your portfolios. 

Before thinking about how to include alternatives, let us ask ourselves one question: Should I include them in the first place? 

 

Should I Include Alternatives In My Portfolio?

 

As mentioned in Part 1, alternatives provide more diversification to have better returns and lesser risks. Among the alternatives, real estate investment trusts (REITs) and commodities are easy to understand, and could be included into your main investment portfolio. Following the Bedokian Portfolio’s make-up, REITs can make up 20% to 40% of your portfolio, while commodities would be about 5% to 10%¹. There are many types of securities and investment vehicles to invest into these two, ranging from individual shares/units of REITs, to exchange traded funds and unit trusts, to owning the actual physical thing (for gold and silver in the form of bullion).

 

For properties I had written up an earlier piece here. You may want to check it out.

 

Private equity (PE) and hedge funds, as said earlier in the previous post, are only available to sophisticated investors, so is not available directly to us retail investors, whether we want them (or like them) or not.

 

For derivatives, unless you have a sound understanding on how they work and the strategies to implement them, it is not advisable to go into them. Furthermore, derivatives are leveraged products, so your returns and risks can be amplified, too.

 

The verdict on whether cryptocurrencies (cryptos) are a financial good or an item in the greater fool theory is still out there, so if you are not comfortable going into them, then just stay out. If you are comfy with cryptos, be sure to read up on them (blockchains, DeFi, exchanges, etc.), for now they are in the realm of the Wild West.

 

If you have any collection sets or items (stamps, coins, comic books, etc.) accumulated from your hobby days, know their appraised value and in the company of like-minded people who appreciates them, you may consider monetizing your collectibles. However, do note that collectibles, unlike securities and investment vehicles, there is no common market for them, and the value would depend on the appraiser/buyer and the “flavour of the moment” (think tulips). If any returns are derived from them, it would be more of a one-off or a “few-offs”.

 

Easier Way To Go Into Some Alternatives

 

If you are not a sophisticated investor and yet want to go into PE and hedge funds, there is a way about it, and that comes in the form of exchange traded funds, or ETFs. There are at least a couple of ETFs containing listed PE firms (or you could invest in them direct by buying their shares). Most hedge fund ETFs do not really invest in the hedge fund companies themselves, but rather on the strategies employed (equity long/short, arbitrage, etc.). 

 

There are ETFs for derivatives, which I had shared on how to invest in oil using futures², plus other commodities futures. Leveraged and inversed ETFs are other examples of using derivatives. Options trading is gaining acceptance among investors and traders nowadays, and there are some options strategies available via ETFs, especially covered calls.

 

Lastly, there are also ETFs on cryptos, but most of them are centred on Bitcoin.

 

Most of the ETFs mentioned above are listed overseas, especially in the United States. You can look them up by visiting ETF-centric websites, such as www.etf.com or www.etfdb.com.

 

How To Fit Them Into My Portfolio?

 

From my point of view, PE and hedge fund ETFs should be placed as a sub-category under the equities asset class of an investment portfolio, and no more than 10% of the entire portfolio. The reasons of grouping them as equities are that PE ETFs are still made up of company shares, while a majority of hedge fund strategies involve equities one way or another.

 

Derivatives which do not belong to commodities (i.e., leveraged, inversed, options) and cryptos should be placed separately in a trading portfolio and away from the investing one, due to the holding timeframe and nature of the financial goods.

 

In conclusion, the advice of “know what you are doing” is paramount in any investment/trading decision. Going into alternatives for the sake of “jumping onto the bandwagon” is a strict no-no.

 

Stay safe, stay invested.

 

1 – The Bedokian Portfolio (2^nd Edition). P70-71.

2 – ibid. p42-43.