Understanding Investing

5 Myths About Alternative Investments

Not all characteristics of alternative investments are widely understood by investors. Read on as we demystify 5 common misperceptions.

Myth 1: Alternatives are only available to ultra-high-net-worth investors and institutions.

Truth: There’s a broad selection of offerings within the alternatives universe – and they can appeal to different types of investors. While it’s true that some types of funds may restrict investment to qualified purchasers or accredited investors, other investment vehicles exist that provide access to alternatives without the same restrictions.

Myth 2: Alternatives add investment risk to your portfolio.

Truth: It depends. When looking at an alternative strategy as a standalone solution, it will typically have a higher risk profile than more traditional holdings because of its lower liquidity and higher targeted returns. However, when viewed as part of an overall portfolio, the investment risks may seem more moderate; alternatives are often influenced by different market circumstances than traditional investments like stocks and bonds, and don’t always follow the same performance path. In fact, some alternative strategies, such as market-neutral are designed to lower overall portfolio risk. These characteristics make alternatives an attractive source of diversification and return potential – and even a possible buffer against volatility. Beyond investment risk, it’s also important for investors to be mindful of other potential risks related to the unregulated structure of many alternative investments. Reviewing your overall portfolio risk tolerance is a great place to start.

Myth 3: The illiquidity of alternatives is bad for investors.

Truth: Actually, the illiquid nature of certain alternative investments can potentially be a boon to your portfolio. For example, alternative strategies that are not in daily-liquidity vehicles are less likely to be forced to sell holdings quickly – and at a lower price – than traditional mutual funds, which may need to raise cash to meet daily redemptions. Plus, even though investors may not be able to withdraw funds on a daily basis, this higher illiquidity can allow for investment in possibly higher-yielding or more complex assets.

Myth 4: Alternatives is synonymous with hedge funds and private equity funds.

Truth: Alternative investing is wide-ranging and varied. For example, private credit strategies and certain real estate strategies, typically offered through a similar type of fund as private equity, have seen significant growth since the global financial crisis, when traditional lenders like banks began to change their lending practices. Alternative credit and private strategies like this can offer investors a chance to earn attractive returns over time – and get compensated for higher illiquidity and complexity risks.

Myth 5: Alternatives aren’t a necessary part of your portfolio.

Truth: Especially during times of uncertainty, investors need to look beyond traditional asset classes for other sources of returns in order to meet their financial objectives with greater confidence. By adding alternatives to the mix, investors may be able to enhance portfolio performance, boost diversification and reduce their overall risk. Importantly, alternatives can help investors pursue their goals by being a source of new opportunities and expanding the investable universe.

To learn more about alternatives, visit Understanding Alternative Investments.

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Disclosures

Alternative investments and hedge funds involve a high degree of risk and can be illiquid due to restrictions on transfer and lack of a secondary trading market. They can be highly leveraged, speculative and volatile, and an investor could lose all or a substantial amount of an investment. Alternative investments may lack transparency as to share price, valuation and portfolio holdings. Complex tax structures often result in delayed tax reporting. Compared to mutual funds, private funds are subject to less regulation and often charge higher fees. Alternative investment managers typically exercise broad investment discretion and may apply similar strategies across multiple investment vehicles, resulting in less diversification. Trading may occur outside the United States which may pose greater risks than trading on U.S. exchanges and in U.S. markets. Diversification does not ensure against loss.

There are significant differences between public and private equities, which include but are not limited to, the fact that public securities have a lower barrier to entry than private equity. There is also greater access to information about public companies. Private equities typically have a longer time horizon than public equities before profits, if any, are realized. Public equities provide greater liquidity, whereas private equities are considered highly illiquid. Private credit involves an investment in non-publicly traded securities which are subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investments in Private Credit may also be subject to real estate-related risks, which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factors beyond a manager’s control. Liquid alternatives are generally investment vehicles that offer typical hedge fund strategies in a mutual fund format with daily liquidity. Managed futures contain heightened risk, including wide price fluctuations and may not be appropriate for all investors. Short selling and short position derivative activities are considered speculative and involve significant financial risk. Short positions profit from a decline in price but can generate a loss if the price increases. Shorting may also result in higher transaction costs which reduce return.

This is neither an offer to sell nor a solicitation of an offer to buy interest in any product or strategy in any jurisdiction. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that any investment will achieve its objectives, generate profits or avoid losses. Alternative investments may be appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns.

This material contains the current opinions of the author but not necessarily those of PIMCO, and such opinions are subject to change without notice.  This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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