Alternative Investments: Investing in Alternatives

The Sharpe ratio also has another important limitation, which is that it cannot directly tell the investor much about the strategy used.

Investors who are seeking to optimise their portfolio are equally interested in information about the correlation of the investment. While, alternative investment managers are increasingly trying to provide information on correlations to the major market indices and other strategy types for investors, this information also has limitations.

Correlations are calculated by grouping alternative investments together into peer groups with similar risk/return profiles, so correlation data will depend on the groupings. Investors may, therefore, need to consider other data in order to select the right strategies for their portfolio

Alternative investment managers often provide investors with information about their risk/return profiles. These usually include data on maximum drawdowns, which refers to the most amount of money lost in their worst months, as well as data on the number of drawdowns.

Managers are also increasingly providing figures that relate to volatility, leverage, concentrations of stock positions, liquidity and stress-test results. They may also include measures of their total exposure to the market, called value at risk or VAR, which include the notional value of any derivatives.

When investors are comparing alternative investments on the basis of these statistics, it is important to determine the algorithms used by the manager as these may not necessarily be uniform across the market. Also, they will need to monitor that these statistical parameters are maintained by the manager. The consistency with which managers achieve the same results is an important way to judge the performance of alternative investments.