Alternative Investments: Fundamentals

The term non-correlated asset classes covers a whole range of potential investments, including real estate, private equity, and commodities, but also alternative investment strategies.

Correlation refers to the extent to which prices move in the same direction. And assets with prices which more often than not move in opposite directions are called 'negatively correlated'.

With alternative investments, the manager is still usually investing in stocks and bonds, but seeks to generate returns from the relationships between securities rather than the directional fortunes of an asset class.

Non-correlated investment strategies can be used by investors to neutralise, or counterbalance, the risk that one, or more, of the investments in a traditional portfolio of stocks and bonds falls in value. In order to do this, investors typically place between 5% and 20% of their total investment portfolio into alternative investments to protect the remainder of the portfolio from downside risk.

Minimising downside risk is one of the fundamental characteristics of alternative investment strategies. Or, to put it another way, individual alternative investment managers ideally seek to generate positive returns irrespective of the direction of the market.

For many traditional investors, this sounds at first like hocus-pocus. To understand how it can be done, it is worth taking an historical look at the first alternative investment fund.