Alternatives can come in from the cold

The rise of the alternative investment sector has been going on for about the past 18 months and has been driven primarily by the threats of low return environments.

But how do planners describe an alternative investment when they are sitting in front of clients, especially when so many products are clamouring to have that title attached to them?

Obviously some investments that fall well outside the mainstream are and should be considered to be alternative. Such investments include private equity and venture capital for instance, mainly because they fall outside of the definitions of the established asset classes.

However, other investments, such as socially responsible investments (SRIs),while different, should not be regarded as alternative.

The reason for this is that these investments are working within established investment sectors and rather than offer a whole new way of investing, apply new techniques to picking investments in that sector.

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An example of this is the whole ethical investment or SRI sector in which these funds, usually equity vehicles, apply a set of screens to determine which stocks make it into the fund. How different is this then from small cap or regional funds, which also apply screens but based on different criteria such as market capitalisation or the country in which the company is based.

The key difference is that SRI funds can use both positive and negative screens but this is still no different than an Australian small cap fund which makes use of multiple screens as well.

The point could be argued that hedge funds walk the line between being alternative, as they work in established investment sectors, but take the extra step of placing more reliance on the skill of managers than they do on the performance of the underlying stocks.

Those managers who pick stocks for other investments may debate the point about the level of reliance on a manager as being the defining point of an alternative investment.

These comments are not designed to denigrate the role of these investments in providing diversity to clients. Rather, it is important that planners, and in turn their clients, understand what is being labelled as alternative in the market at present.

By now a number of people will be penning letters to defend the status of alternative investments but in a bid to prevent that, let’s define what alternative really means.

Without working through a dictionary definition, it would be safe to say that alternative investments are those which offer another or different choice to those already in the market. But based on this, many investment vehicles could be considered alternative as long as they have enough characteristics that differ from other investments within the same asset class.

Rather, alternative should be considered to be those investments which have found new ways to provide returns to investors or are pushing the well-worn bounds and have yet to find widespread popularity.

Based on this definition, SRIs and possibly even hedge funds may have to reconsider how they choose to be labelled in the future.