OCEAN CITY — We expect returns from traditional asset classes to be more moderate going forward, accompanied by greater volatility. This will compel investors to manage portfolio risk more carefully and look for alternative sources of return. While not appropriate for everyone, we believe Alternative Investments (AI) can help.
AI strategies can be used to take advantage of current market opportunities, including higher volatility, and longer term opportunities for enhanced returns. Alternative Investments are not a homogeneous group of assets; rather,
they offer various ways to target particular objectives, depending on investors’ goals. Depending on the strategy, they have the potential to mitigate portfolio volatility, provide uncorrelated sources of return, or access exclusive markets. However, these benefits must be weighed against the relevant risks and limitations.
The stop-and-start global economic recovery and uncertain policy outlook for central banks suggest that the road ahead will be much bumpier than it has been over the last several years, as the markets have been largely devoid of any significant selloffs. The recent rise in volatility in the currency and commodity markets
are examples, and if skillfully managed, they could generate attractive long-term return for investors.
High volatility also creates the potential for more variation in company fundamentals across industries, countries, and asset classes. AI strategies that can skillfully navigate such dispersion, such as equity long/short and relative value credit, are likely to benefit.
We believe various strategies, including private equity, real estate, and distressed debt can offer higher potential returns by committing capital to unique opportunities over longer time horizons.
Academic research has estimated the historical “premium” generated by the illiquidity of such investments at more than 3% annually. Additionally, these strategies are well-positioned in the current environment of tighter lending standards in traditional lending channels and increased demand for funding by private ventures and real estate companies.
At the same time, cash on corporate balance sheets has grown to record levels, given rising sales and profits. Companies have looked to use this cash for deal-making, including mergers, acquisitions and divestitures, and we expect this higher level of activity to continue. Event-driven and merger arbitrage hedge funds, as well as private equity buyouts and venture capital, are examples of strategies that can position investors for such opportunities.
It is important to note that, while there are significant advantages to Alternatives Investments, they are also complex strategies that carry risks above and beyond those associated with traditional assets, and are therefore not suitable for all investors. Certain strategies and techniques used to enhance returns (e.g., short selling, leverage, investing in illiquid assets and securities, etc.)
can also potentially increase investment risks, including the loss of
principal. Before investing in AI, clients should consider their overall financial situation, how much money they have to invest, their need for liquidity, and their tolerance for risk.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)