Question

1) Explain the advantages of alternative assets from the standpoint of a Markowitz efficient frontier. Relate international assets - and alternative assets - as well as fixed income, equities, and cash to the discussion.

Answer 1

Alternative investment as a whole has grown twice as fast as traditional investment since 2005. While alternatives were previously available only to public pension funds, sovereign wealth funds and endowments, affluent individuals are starting to tap into this market.

The advantages of alternative assets from the standpoint of a Markowitz efficient frontier:

1. Generally speaking, assets that have a low correlation and expose the investor to a variety of risks will provide the best opportunities for diversification. Hence, alternative investments help in diversification of risk.

2. The Markowitz efficient frontier moves up and to the left, by including the alternative investments in portfolio. The aim of alternatives is not always to have high short-term returns, but to protect and generate long-term, consistent returns over time during drawdowns (bearish market). Alternatives are therefore capable of dampening volatility and providing a degree of downside protection when markets do not do so well.

3. Alternative invetsments have generally higher returns than tradiitonal stocks and bonds (and other fixed income securities), for example international assets, REITs, large cap, small cap funds, private equity etc.