Article Spotlight – Alternative Investments and Their Role in Portfolios

Last month Fidelity published research on the performance of portfolios with and without alternative investments (e.g., private equity, venture capital, hedge funds, etc.). Fidelity looked at “16 traditional and alternative investment categories from 2005 through 2021 and ranked them based on three key metrics: annualized returns, performance amid poor public equity market returns, and diversification benefits”. The study generally showed that “private equity, private credit, and private real estate... demonstrated higher returns than most other asset categories over the period... and hedge fund strategies, private real estate, and late-stage venture capital (within private equity) offered enhanced portfolio diversification”.

It was a great read and while we’ve linked the full article in the footnotes, we’ve also highlighted three key takeaways below! 


First, private equity, private credit, and real estate demonstrated higher returns than most asset classes from 2005 to 2021 

Fidelity's comparison of 16 alternative investment asset classes from 2005 to 2021 showed that private equity (both buyout and venture capital) was by a wide margin the best performing asset class in terms of returns (Exhibit 1). Venture capital performed almost twice as well as U.S. Large Cap stocks and buyout private equity performed nearly 50% better than U.S. Large Cap stocks.  

Exhibit 1: Fidelity research indicated that private equity outperformed all other traditional and alternative asset categories over the period studied 

Fidelity commented that “among the alternatives we studied, private equity, private credit, and private real estate (a real asset) demonstrated higher returns than most other asset categories over the period; the returns of private equity, direct lending (within private credit), private real estate, and hedge fund strategies held up relatively well amid poor public equity performance”. 


Second, including select alternative investments may enhance risk-adjusted returns 

The study showed that from 2005 to 2021 certain alternative asset classes, as part of a multi-asset class portfolio, could enhance risk-adjusted returns for the portfolio overall. In addition to returns, Fidelity looked at performance during a down turn in U.S. equity and the impact on diversification. The results (Exhibit 2) showed that buyout private equity and venture capital had top-quartile performance amid a downslide in US public equities, and venture capital displayed above average diversification benefits while buyout had limited benefits to diversification.

Exhibit 2: Within multi-asset class portfolios, individual categories of alternatives have offered enhanced returns, lesser downside amid poor public equity performance, or diversification, among other potential benefits relative to traditional asset classes. 

The 2005 to 2021 data was also used to understand how portfolios would have performed that contained only traditional assets verse portfolios composed of traditional and alternative assets. This showed that a portfolio containing alternative assets had “a higher level of return for the same unit of risk” (Exhibit 3).

Exhibit 3: Incorporating a basket of alternative investments as part of a multi-asset class portfolio may enhance risk adjusted returns 

The grey line in the chart “represents a baseline efficient frontier that includes nine traditional asset classes (defined below). The green line represents a portfolio that may also include seven alternative investment data sets”. Fidelity expanded that “this improved efficiency is the result of including additional asset categories with diversification benefits or higher historical returns at an equal or lower expected level of risk”. 


Third, alternative investments were traditionally available only to the extremely wealthy, but this is slowly changing 

While alternative investments may have performed well historically, most “alternative investment strategies were at one time largely available only to institutional investors”. Many of these institutions invest a significant amount in alternative investments. In fact, “on average, pension funds reported a 22% allocation to alternatives, while endowments and foundations reported an average allocation of 32%”. While these institutions and ultra-high net worth individuals have invested significant sums in alternative, adoption of alternative investments among everyday investors has been far more limited. There are several factors contributing to this such as limited access to alternatives and high investment minimums (we wrote more on this here), but over the past few years there have been exciting efforts to increase alternative investment options for everyday investors and close this access gap, however there is significant distance left to go.



1 Source: Fidelity Investments, Alternative Investments and Their Roles in Multi-Asset Class Portfolios, August 2022.

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