Managing Market Volatility: The ‘Why’ and ‘What’ of Alternative Investments

For some investors, alternative investments may offer the potential for improved diversification while helping to mitigate downside risk.

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Podcast Transcript

Host: Paige Green, Senior Director of Sales, Wells Fargo Private Bank

Guest: Dave Roda, CFA, Regional Chief Investment Officer, Wells Fargo Private Bank

[Paige]: 

Hello, I'm Paige Green, Senior Director of Sales for Wells Fargo Private Bank. Joining me today to discuss strategies to manage market volatility in your portfolio is Dave Roda, Regional Chief Investment Officer for the Southeast region. Dave, thanks for joining us today.

[Dave]:

Thanks, Paige. It's good to be here.

[Paige]:

So, Dave, with the news headlines about Brexit and our contentious elections fueling financial market volatility, should investors be looking at alternative investments as a way to manage risk in their portfolios?

[Dave]:

Absolutely. While not suitable for everyone, alternative investments could be an option for qualified investors. 

[Paige]:

All right, great. Before we dive in, it's been my experience that alternative investments are generally misunderstood and underutilized. So let's take a step back. Could you just explain to us what alternative investments are? 

[Dave]:

Sure. at a basic level, alternative investments include nontraditional investments, which range anywhere from low-volatility fixed-income arbitrage funds to more aggressive commodities trading strategies. The growing universe of alternative strategies and the fund structures that they're housed in represents a potential opportunity to improve diversification and risk management as well as to gain access to unique capital appreciation or income opportunities that are not readily available in the publically traded stock and bond markets.

Now, while it is important to realize that alternative investments, such as hedge funds, are not suitable for everybody, qualified high-net-worth individuals with long-term investment goals could potentially improve the likelihood of achieving their investment goals by adding well-managed alternative investments in the appropriate amounts to their traditional stock and bond portfolios. 

[Paige]:

Great. Thank you for that overview. So with some of the emerging themes we've seen recently — rising stock performance dispersion and the market volatility — are there strategies that can weather this type environment?

[Dave]:

In our opinion, equity long/short hedge funds are well positioned to take advantage of these types of market conditions. By definition, long/short managers take views on both sides of the market. They buy stocks that appear undervalued based on their analysis and they sell short (or borrow shares to sell and later repurchase at a lower price) that they think are overvalued or fundamentally at risk. Of course, short sales could result in potentially unlimited loss for the investment since the market price of the securities sold short may continuously increase. Also, taking short positions in securities is a form of leverage, which may cause a portfolio to be more volatile, but when executed well, this active approach to limiting market exposure in the portfolio can potentially mitigate losses during periods of market volatility. Now due to the speculative nature of the investments, however, qualified, high-net-worth investors should be prepared take these additional risks that are associated with short selling. 

[Paige]:

Really great points around the short selling. Another hot topic, Dave, is the low rate environment we're experiencing. Unprecedented bond buying programs by global central banks have pushed the government bond yields to record lows, and in some cases to negative yield levels. Investors that are searching for income from their investments, they're really being challenged. What is our position on this?

[Dave]:

It's definitely a challenging environment for income investors, Paige. In our view, interest rates are likely to remain low for the near term, but we do expect rates to rise modestly over time as economies show signs of improvement. While we advise clients to maintain allocations to short- and intermediate-maturity investment grade bonds, we strongly believe that they should diversify income streams. One way to accomplish this is by adding private debt investments to their portfolios. In private debt investments, an investor acts as a lender to private companies directly and the loans have specific contractual interest rate and repayment schedules. Once again, qualified high-net-worth investors should be aware of the risks associated with private debt strategies, such as potential for default, limited liquidity, the creditworthiness of the companies borrowing the money, and the infrequent availability of independent credit ratings for private companies. Their investment professional can help them weigh the potential benefits against the risks to determine whether the investment is suitable for their specific circumstances.

[Paige]:

Thanks, that's some great insight, Dave. So let me just sum this up: Basically, when used appropriately, alternative investments can help to mitigate downside risk while offering investors the potential for improved diversification opportunities. Does that sound about right?

[Dave]:

Absolutely, and I want to reiterate that while hedge funds are not suitable for everyone, qualified high-net-worth investors with long-term investment horizons could potentially improve the likelihood of achieving their investment goals by adding alternative strategies in the appropriate amounts to their traditional stock and bond portfolios.

[Paige]:

Well, Dave, as always thanks for sharing your perspective. And I'd to thank our listeners for joining us on this podcast. If you have any questions about your investment strategy, please contact your investment professional. And again, thank you for joining us. 

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Risk Considerations

Alternative investments, such as hedge funds and private debt funds, are not suitable for all investors. Any offer to purchase or sell a specific alternative investment product will be made by the product's official offering documents. They are only available to persons who are "accredited investors" or "qualified purchasers" within the meaning of the U.S. securities laws. Alternative investments are complex investment vehicles which generally have high costs and substantial risks. The high expenses often associated with these investments must be offset by trading profits and other income. They tend to be more volatile than other types of investments and present an increased risk of investment loss. There may also be a lack of transparency as to the underlying assets. Alternative investments are subject to fewer regulatory requirements than mutual funds and other registered investment company products and thus may offer investors fewer legal protections than they would have with more traditional investments. Additionally, there may be no secondary market for alternative investment interests and transferability may be limited or even prohibited. Other risks may apply as well, depending on the specific investment product. Investors should carefully review the prospectus, private placement memorandum or other offering documents for complete information regarding terms, including all applicable fees, as well as risks and other factors that should be considered before investing. 

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