Contents vs. Containers: Integrating Alternatives into Your Investment Plan
June 30, 2013 | Topics: Alternatives
- Investors should consider both the "contents" (underlying investments) and the "container" (legal structure) when evaluating alternative investments
- Innovations in alternative investments are making them more accessible and easier for investors to use
- A portfolio should hold a variety of "contents" as well as "containers" to reap the benefits
Many consider investments such as hedge funds and private equity as stand-alone asset classes that have little to do with more traditional asset classes such as stocks or bonds. However, alternatives actually represent different approaches to investing across a variety of markets, assets and strategies.
A useful way to think about alternative investments is to differentiate between what we would term "contents" and "containers." Certain investments, such as currency and real estate investments, are truly alternative assets in that they have little relation to the performance of traditional stock or bond investments. Then there are alternative strategies—those that trade in predominantly the same markets as traditional investments, but approach the markets in a unique way, using, for instance, long/short or arbitrage strategies. Either way, it is the "contents" (as a product of their mix of underlying risk factors) that determine how these investments are expected to perform relative to traditional asset classes.
The "containers" differentiation refers to the types of vehicles in which these investments might be found, such as hedge funds, private equity funds and mutual funds—all of which are structured differently for a variety of management, liquidity, legal or regulatory reasons. These vehicles may include similar investments, but can encompass many styles and methods of investing across different markets. Hedge funds, for example, are categorized this way because their goal is to mitigate (i.e.,"hedge out") certain risks that are inherent in traditional asset classes, and their focus is on producing returns that are less correlated with the equity and fixed income markets—not because their "contents" are all the same.
These categorizations can help investors diversify their portfolios not only by investment type, but by investment vehicle. Through the various "contents," investors can diversify the forms of risk in their portfolios and gain exposure to different areas of the market. Meanwhile, the different "containers" can be a useful way to think about investing for different needs (e.g., liquidity needs, transparency needs, ease of access, etc.).
Understanding the Range of Investment Choices
The choice of investments available to investors is growing, and with it, the scope to find greater diversification. Adding alternative investments to a traditional portfolio has the potential to enhance returns, while also reducing risk, because they don't typically move in tandem with other parts of a portfolio. Due to a number of innovations in product creation, alternative investments today come in a variety of packages, span a range of strategies and are available to nearly all investors. The information below is designed to help you weigh some important factors when selecting individual investments.
|Open-End Mutual Funds||Registered Closed-End / Private Funds||Unregistered Private Funds|
|Accessibility (Investor Qualifications)||No/low barriers to investing||Typically requires the investor to be an "Accredited Investor" |
(Has $1 million or more in net worth and/or a pre-specified annual income)
|Usually requires the investor to be a "Qualified Purchaser" (Has $5 million or more in investable assets)|
|Investment Universe||More constrained by regulatory restrictions||Broader opportunity set||Largest opportunity set|
|Transparency||High||Moderate to high||Typically limited|
(Typically starting at $1000)
(Typically $10,000 - $50,000)
(Typically $100,000 or more)
(Typically monthly or quarterly)
(Typically monthly or quarterly, may be based partly on estimated value of illiquid securities)
|Fees||Management fee + other expenses||Management fee + other expenses: may be distribution and/or performance fees||Management fee + other expenses: likely to be distribution and performance fees|
|Constraints Around Leverage/Shorting||High regulatory constraints||Moderate/ some regulatory constraints||Typically unconstrained|
|Typical Fund Structure||Registered Investment Company||Registered Investment Company or Limited Partnership||Limited Partnership|
|Tax Reporting||Form 1099||Form 1099 or Schedule K-1 (varies by product)||Schedule K-1|
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Incorporating alternative investments into a portfolio presents the opportunity for significant losses including in some cases, losses which exceed the principal amount invested. Also, some alternative investments have experienced periods of extreme volatility and in general, are not suitable for all investors.
Investing in alternative strategies such as a long/short strategy, presents the opportunity for losses which exceed the principal amount invested.
Hedge funds may not be suitable for all investors and often engage in speculative investment practices which increase investment risk; are highly illiquid; are not required to provide periodic prices or valuation; may not be subject to the same regulatory requirements as mutual funds; and often employ complex tax structures.
Utilizing private equity involves significant risks along with the opportunity for substantial losses.
Investors should consider the investment objectives, risks, charges and expenses of any fund carefully before investing. The funds' prospectuses and, if available, the summary prospectuses contain this and other information about the funds, and are available, along with information on other BlackRock funds by calling 800-882-0052. The prospectus and, if available, the summary prospectuses should be read carefully before investing.
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