Over the last few years, alternative investments have earned their rightful place in the asset allocation makeup of an investor's portfolio. Alternatives can provide non-market correlated diversification that mitigates the volatility often experienced in a traditional stock and bond portfolio. Here at Wise Riddell, we actively incorporate alternative investments into our clients' portfolios in an effort to provide superior returns with reduced volatility.
However, extensive due diligence is performed before incorporating an alternative into a client's portfolio. Several considerations are made when reviewing the suitability of an alternative, including the liquidity (or lack thereof), the tax efficiency, and the history of the investment and its manager.
When reviewing the historical performance of an investment, we often look at the consistency of the investment's performance, especially in particularly unfavourable years in the equity market. This can help to identify the investment's negative correlation to the market's performance – a key attribute to a true alternative investment. It is critical to evaluate how the manager reacts in each stage of the economic cycle and ensure they are adhering to the investment's core mandate. The ideal alternative investment provides consistent, unwavering returns earned by an experienced manager who holds strong convictions.
Many clients would ask, "if you can invest in something that is going to provide strong, consistent returns year after year, why don't you invest all of my money in alternatives?". One of the important considerations to make when investing in alternative investments is liquidity, or rather, illiquidity. Due to the nature of alternatives – where the underlying investments are often hard assets – it is difficult to provide investors with immediate liquidity. When investing in alternatives, it is typical to experience lock-up periods and/or extensive settlement times when redeeming capital. Settlements of 30 to 90 days upon redemption are quite common, and lock-up periods from one to five years are not unusual, but anything beyond that should be scrutinized. Reviewing the liquidity restrictions of the asset is crucial to the due diligence of any alternative investment. Because of this constraint, it is imperative to consider your investment time horizon and potential limitations beforehand. Measuring risk versus reward of an alternative investment will often come down to individual circumstance and personal liquidity requirements.
As with any investment, it is important to understand the tax treatment of the distributions received in a corporate or personal non-registered investment account. Based on the underlying asset and its respective earnings, many alternative investments produce interest income, which is taxed most punitively in a non-registered account. While these products may make for a great investment, they are best reserved for registered accounts where the income type is not of concern. When selecting investments for a personal or corporate investment account, we would recommend products that provide either return of capital or deferred capital gains, both of which are the most favourable distribution from a tax standpoint.
While we believe they have earned their place in any investment portfolio, there are many considerations to make when reviewing alternatives. It is critical to determine your financial goals and limitations before deciding whether an investment is right for you. Wise Riddell's Wealth Management team is here to help you make that decision.