Value added investment strategies aim to generate excess returns above a benchmark by actively managing a portfolio. These strategies go beyond traditional stocks and bonds to include alternative investments like private equity, hedge funds, real estate and commodities. By diversifying into these assets, investors can tap into return sources not available in traditional markets. However, alternatives come with higher fees, complexity and illiquidity. Investors must understand the risks and have a long-term horizon to benefit from the illiquidity premium. Overall, incorporating alternatives in moderation can boost portfolio returns for suitable investors.
Private equity targets higher returns through active company management
Private equity firms take active ownership stakes in companies and work to improve operations, strategy and finances. This hands-on approach aims to unlock value not recognized by public markets through IPO exit. However, private equity is highly illiquid with multi-year lockup periods. Investors must also pay substantial fees for access to top-tier managers with proven value-adding capabilities.
Hedge funds follow flexible strategies to generate alpha
Hedge funds utilize alternative strategies like short selling, leverage and derivatives to pursue absolute returns regardless of market conditions. Managers have flexibility to take long and short positions across diverse securities. Top-performing funds can deliver uncorrelated returns and positive alphas. However, many funds fail to outperform simple long-only investing after fees.
Real estate provides income and diversification benefits
Real estate investment trusts (REITs) and direct property investments offer attractive income, inflation hedging and low correlation to stocks and bonds. However, real estate exhibits high cyclicality and illiquidity. Investors must carefully evaluate property fundamentals, financing terms, tenant credit risk and local market supply/demand dynamics.
Commodities deliver positive expected returns over long-horizons
Historically, broad commodities indexes have generated positive real returns over 5-10 year periods due to rising global demand and depletion of finite resources. Commodities like energy, metals and agriculture offer diversification since their prices depend on supply/demand fundamentals, not equity valuations. However, commodities experience high short-term volatility and carry price risk.
Incorporating alternative investments can enhance portfolio diversification and expected returns for suitable investors with a long-term horizon. However, alternatives come with elevated illiquidity, complexity and fees. Limiting overall allocation to 10-20% of a portfolio allows investors to tap into alternative return sources while moderating risks.