Scatter plot showing annualized risk and return of allocations including and excluding alternative investments, like hedge funds, private real estate, private equity, and private debt, since 2000. The inclusion of alternatives contributed to higher return and lower risk. As of September 2023, data is as follows–20% U.S. equities, 50% U.S. bonds, 30% alternative investments annualized return: 6.2% and annualized standard deviation: 4.9%. 30% U.S. equities, 70% U.S. bonds annualized return: 4.9% and annualized standard deviation: 5.6%. 35% U.S. equities, 35% U.S. bonds, 30% alternative investments annualized return: 6.7% and annualized standard deviation: 6.8%. 50% U.S. equities, 50% U.S. bonds annualized return: 5.5% and annualized standard deviation: 8.1%. 50% U.S. equities, 20% U.S. bonds, 30% alternative investments annualized return: 7.1% and annualized standard deviation: 8.9%. 70% U.S. equities, 30% bonds annualized return: 6% and annualized standard deviation: 11%.
Risks
Asset Class Risk Disclosure
Investing in stocks involves risk and their returns and risk levels can vary depending on prevailing market and economic conditions. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Foreign investing has additional risks including currency, transaction, volatility and political and regulatory uncertainty. Alternative investments, such as hedge funds and private equity/private debt funds, are not appropriate for all investors and are only open to accredited or qualified investors within the meaning of the U.S. securities laws. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. While investors may potentially benefit from the ability of alternative investments to potentially improve the risk/reward profiles of their portfolios, the investments themselves can carry significant risks. There may be no secondary market for alternative investment interests, and transferability may be limited or even prohibited. Hedge fund strategies, such as Equity Hedge, Event Driven, Macro, and Relative Value, may expose investors to risks such as short selling, leverage, counterparty, liquidity, volatility, the use of derivative instruments, and other significant risks. Private real assets are not appropriate for all investors. REITS have special risks, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions.
Definitions
Index definitions
HFRI Fund Weighted Composite Index is a fund-weighted (equal-weighted) index designed to measure the total returns (net of fees) of the approximately 2,000 hedge funds that comprise the Index. Constituent funds must have either $50 million under management or a track record of greater than 12 months. Sub-strategies include: HFRI Event-Driven, Distressed/Restructuring Index, and HFRI Event-Driven (Total) Index.The HFRI indexes are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indexes may not be complete or accurate representations of the hedge fund universe and may be biased in several ways.
Cambridge Associates LLC U.S. Private Equity Index® uses a horizon calculation based on data compiled from more than 1,400 institutional-quality buyout, growth equity, private equity energy, and subordinated capital funds formed after 1986. The funds included in the index report their performance voluntarily and therefore the index may reflect a bias toward funds with records of success. Funds report unaudited quarterly data to Cambridge Associates when calculating the index. The index is not transparent and cannot be independently verified because Cambridge Associates does not identify the funds included in the index. Because Cambridge Associates recalculates the index each time a new fund is added, the historical performance of the index is not fixed, can’t be replicated and will differ over time from the day presented. The returns shown are net of fees, expenses and carried interest. Index returns do not represent fund performance.
The Burgiss Private Debt Index is a pooled quarterly time weighted rate of return series based on data compiled by the Burgiss Group, LLC (Burgiss) from over 800 private debt funds (generalist, senior, mezzanine, and distressed debt), including fully liquidated partnerships, formed after 1986. The return series is net of fees, expenses, and carried interest. The benchmark is issued on a quarterly basis, approximately 80 calendar days after quarter end. Index returns do not represent fund performance.
The NCREIF Property Index is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.
The Bloomberg U.S. Aggregate Bond Index is a broad-based measure of the investment grade, U.S.-dollar-denominated, fixed-rate taxable bond market.
The S&P 500 Index is a market capitalization-weighted index generally considered representative of the U.S. stock market.
Sources: © Morningstar Direct, All Rights Reserved1, and Wells Fargo Investment Institute. Data from January 1, 2000, to September 30, 2023. U.S. bonds = Bloomberg U.S. Aggregate Bond Index. U.S. equities = S&P 500 Index. 20% alternatives investments consists of 10% hedge funds (HFRI Fund Weighted Composite Index), 10% private equity (Cambridge Associates U.S. Private Equity Index), 5% private debt (Burgiss Private Debt Index), and 5% private real estate (NCREIF Property Index). For illustrative purposes Index returns do not represent investment returns or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for expenses or taxes applicable to an actual investment. Unlike most asset class indexes, HFR Index returns reflect deduction for fees and expenses. Because the HFR indexes are calculated based on information that is voluntarily provided actual returns may be higher or lower than those reported. The HFRI indexes are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indexes may not be complete or accurate representations of the hedge fund universe and may be biased in several ways. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Standard deviation is a measure of the volatility of returns. The higher the standard deviation, the greater volatility has been.
Diversification strategies do not guarantee investment returns or eliminate the risk of loss. See the “Index Definitions and Asset Class Risk Disclosures” link above for asset class risks and index definitions.
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Key Takeaways
- Adding alternative investments to an allocation with a blend of traditional stocks and bonds has historically increased returns and decreased risk.
- Alternative investments can provide valuable diversification, especially during time periods when the correlations between U.S. stocks and bond prices have been positive.