Course:

COMMODITIES AND
ALTERNATIVE INVESTMENTS
Course Instructor: Umang Somani, CAIA (vf-umang@gim.ac.in)

Session 5: Goals of Alternative

Investments
1
Why do investors pursue Alternative Investments?

2
Primary goals of investing in Alternative Investments

• Active Management of assets

• Attain Absolute and Relative returns
• Return enhancement
• Risk Diversification

3
Primary goals of investing in Alternative Investments

• Active Management of assets

• Attain Absolute and Relative returns
• Return enhancement
• Risk Diversification

4
Active Management of Assets

• Active management refers to efforts of buying and selling securities to

earn superior combinations of risk and return.

• Alternative investment analysis typically focuses on evaluating active

managers and their systems of active management, since most alternative
investments are actively managed.

• Active management is the converse of passive investing, which tends to

focus on buying and holding securities in an effort to match the risk and
return of a target, such as a highly diversified index.

5
Primary goals of investing in Alternative Investments

• Active Management of assets

• Attain Absolute and Relative returns
• Return enhancement
• Risk Diversification

6
Absolute Returns

• An absolute return standard means that returns are to be evaluated

relative to zero or relative to the riskless rate and therefore independently
of performance in equity markets, debt markets, or any other markets.

• Thus an investment program with an absolute return strategy seeks

positive returns unaffected by market directions.

• An example of an absolute return investment fund is an equity market

neutral hedge fund with equal-size long and short positions in stocks that
the manager perceives as being undervalued and overvalued, respectively.

7
Absolute Returns

• The fund's goal is to hedge away the risk return related to the level of the
equity market and to exploit security mis-pricings to generate positive
returns.

• By doing away with conventional benchmarks and instead striving for

consistently positive performance and lower levels of volatility, absolute
return funds can offer a number of potential benefits in the form of:
• Reducing overall portfolio volatility
• Limiting losses in down markets
• Broadening the sources of investment returns
• Improving a portfolio’s risk-adjusted return

8
Relative Returns

• Absolute return differs from relative return because it is concerned with

the return of a particular asset and does not compare it to any other
measure or benchmark.

• A relative return standard means that returns are to be evaluated relative

to a benchmark.

• An investment program with a relative return standard is expected to move

in tandem with a particular market but has a goal of consistently
outperforming that market.

9
Relative Returns

• An example of a fund with a relative return strategy is a long-only global

equity fund that diversifies across various equity sectors and uses security
selection in an attempt to identify underpriced stocks.

10
Primary goals of investing in Alternative Investments

• Active Management of assets

• Attain Absolute and Relative returns
• Return enhancement
• Risk Diversification

11
Return Enhancement

• An obvious goal of virtually any investor is to earn superior returns while

taking less risk.

• If the primary objective of including an investment product in a portfolio is

the superior average returns that it is believed to offer, then that product is
often referred to as a return enhancer.

12
Return Enhancement

• But….

13
Return Enhancement

• These are the strategies which seek to generate returns in excess of public
markets but there is of course no free lunch.

• The higher yield may compensate investors for a lower level of liquidity in
these markets. However, this may not be a problem for longer-term
investors that can hold assets through the cycle.

14
Primary goals of investing in Alternative Investments

• Active Management of assets

• Attain Absolute and Relative returns
• Return enhancement
• Risk Diversification

15
Risk Diversification
• To pursue efficient return streams with an emphasis on reducing the risk of
market drawdowns as well as long-term volatility.

• If the primary objective of including an investment product in a portfolio is

for the reduction in the portfolio's risk that it is believed to offer through its
lack of correlation with the portfolio's other assets, then that product is
often referred to as a risk diversifier.

• These are the strategies that generate returns with a low correlation to
traditional assets, such as certain hedge fund strategies or real assets.

• The addition of these assets to a portfolio might serve to not only cushion
the value of a portfolio in a downturn but in some cases also enhance the
portfolio’s risk adjusted return. 16
What is driving the interest in alternative investments?

17
Key drivers of interest in alternative investments

1. Many investors are tired of high market volatility;

2. Equities remain expensive;

3. Low interest rates are depressing fixed-income returns (not applicable to

the current scenario);

4. Investors are planning for higher inflation;

5. Technology is
• democratizing alternative investments; and
• making certain investment strategies viable.
18
Questions?

19