Don’t Wait for Rough Markets to Build an Alternatives Allocation

Volatility is remarkably low today, but it’s not likely to stay that way. Alternatives have the potential to provide diversification and reduce risk when markets get stormy again. But what’s the best way to design an alternatives allocation?

The recent run of market tranquility makes it easy to forget that we’ve seen more volatility spikes in the past two years than there have been in the previous 20. It’s true that most of these surges were short-lived. But investors shouldn’t expect that they will always be.

Investors who ignore rising US interest rates, global policy uncertainty and political risk—particularly in Europe and other developed regions—do so at their own peril. In fact, the lower the risk, the higher the probability of a sharp reversal.

The good news is that a well-designed allocation to alternative investments may help portfolios weather uncertain market environments. When volatility and market sentiment fluctuate, it tends to cause bigger differences in the return paths of individual securities in equities and fixed income. That creates more opportunities to take advantage of security selection to enhance performance.

The right alternative strategy may also help diversify a portfolio and provide protection in down markets. That’s critical, because the returns of major equity indices haven’t been climbing as steadily as they were before 2015. Volatility, meanwhile, has seen quite a few ups and downs (Display).

But to get the right fit, investors need to have a strong sense of their investment objectives and the alternative design that best complements their portfolios.