Alternative strategies play an important role in the portfolios we manage. As portfolio diversifiers, most of the alternatives we use are defined as real return or absolute return strategies.
Real return strategies combat the effects of inflation. These asset classes are held as an inflation hedge since they tend to benefit or do well with rising inflation. Within our portfolio, these include real estate, commodities and global infrastructure.
Regardless of market conditions, absolute return strategies should provide returns to the portfolio since these strategies have the ability to take both long and short positions, where long positions benefit in rising markets and short positions benefit in declining markets. We also refer to these as risk management strategies, which include managed futures, market neutral and global macro.
While returns of various alternative strategies may lag other asset classes periodically, they help to mitigate overall risk in the portfolio, reducing volatility or limiting the extreme highs and lows. Although these strategies may take away some of the potential upside return if compared to a similarly allocated portfolio without any alternatives, the inclusion of alternatives more importantly limits the downside risk.
When viewing the portfolio over various periods, alternatives can appear to be a drag on performance. The same can be said of traditional asset classes at different points in time. This is to be expected of any well-diversified investment portfolio. Not everything is always going to work at the same time and certainly not everything will fail all at once. That is the beauty of diversification. The real benefit comes from being properly allocated to the various asset classes at all times.
I have heard this put best by our Chief Investment Officer when talking about the risk management strategies in the portfolio and his advice helps to cement the reason why they are held. He suggests to think about them in terms of insurance. We may complain about the premiums paid for carrying insurance, but we sure are glad we had insurance in place when an unforeseen event occurs.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Derrick Wilson is a Portfolio Manager of Manager Selection and Due Diligence for Washington Trust Bank’s Wealth Management & Advisory Services. He is responsible for all external investment manager analysis, selection, monitoring and retention. Derrick holds a BA from Eastern Washington University and MBA from Gonzaga University.