The Upside: Demystifying alternative investments – Practical insights for modern portfolios

What does “alternative investments” mean, and why do they matter now? Join Rory Poole, Director, Alternatives, as he demystifies alternatives, looks at their role in a portfolio, explains how you can access alternatives and addresses common misconceptions.

Transcript

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Hello, and welcome to The Upside.

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I'm Lauren Gardy. Today we're talking about alternative investments and

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I'm joined by our in-house product expert, Rory Poole.

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Rory, why don't you kick off by telling us exactly what you and your team do

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here at Fidelity?

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For sure, Lauren. Thanks a lot for having me today.

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So myself and a team of folks are responsible for

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really all the research and development that we do around the various

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alternative strategies or funds that we offer to investors.

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Happy to unpack some concepts today and talk a little bit about

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maybe a part of investing that investors at home

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are a little bit less familiar with but, hopefully, in the future

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will warm up to a little bit more.

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Great. Let's start from the basics.

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I, myself, I'm just at the beginning of my investment journey, long term time

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horizon, I've been hearing a lot about alternatives.

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There's a lot of buzz around them, seemingly on a lot of investors' minds.

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I'm curious, what actually is classified as an alternative and why

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are so many people interested in them today?

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There's a couple questions within that but maybe we'll just start with

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the simple concept of what is an alternative?

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I think the best way that I would explain it to folks is it's just

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something different. You probably ask, okay, well, different relative to what?

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Different relative to the three kind of core traditional areas that investors

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tend to have capital invested within their portfolio,

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whether that's stocks, bonds or cash.

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To be a little bit more specific, they're different in terms

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of how they behave within the portfolio.

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There may be times when your stock portfolio or

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your bond portfolio is going up, down or sideways, and an alternative

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that you own within that portfolio may be doing something different.

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The benefit of that, which I think we'll probably talk a little bit more about

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today, is that it provides a little bit of an added layer

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of diversification within folks' portfolios to varying

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degrees.

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The second part of your question was kind of

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hinting at the fact like, hey, these are becoming a little more popular, a

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little but more mainstream. Why is that the case?

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I think from my perspective there's really two answers to that.

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The first is simply access.

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Access to alternative solutions or alternative investments

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has gotten dramatically better for the end investor over

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the course of the past 5 to 10 years.

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There's a number of reasons as to why that's the case but

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simply put, it is a lot more feasible, attainable,

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scalable for an investor to actually hold some of these

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options within their portfolio if they choose to do so

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relative to maybe the decades past.

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I think on top of that, like many

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facets of our lives nowadays, there's a big influence

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from the tension that comes from the media as a result of

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that. More access, more options for investors, well,

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the Bloombergs, the CNBCs, whatever investors

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use for the purposes of their financial news will pick that up.

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One of the best examples of that, which is an alternative investment, is

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the emergence of cryptocurrency over the course of the past five or so years.

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You really can't go a day without looking at one of

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these financial websites or financial forums that does not

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necessarily mention that. I think it's the combination of

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end investors having a greater ability to actually own

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some of these things coupled with the fact that media is

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so influential in our day-to-day lives.

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I'm sure we've all experienced how much media influence can impact

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broader decisions too.

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I wanted to dive into something you mentioned about fitting alternatives into a

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portfolio. As I mentioned, I have a long term time horizon compared to someone

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who's more of a retiree, maybe has short term cash needs, how would

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you sort of universally describe alternatives fitting into portfolios and how

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do they work amongst different investors,

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I think that alternatives come in so many different

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shapes and sizes.

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I think there's really something out there for everyone.

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Let's use your comparisons specifically to

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talk about that a little bit more.

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Let's say, Lauren, that, as you mentioned, you are a long term investor,

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maybe you have a slightly higher risk tolerance, there are plenty

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of alternative options out there for folks that may target

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or aim to generate higher returns than that of what you might

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get within a traditional stock portfolio.

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There's some compensations that you potentially have to pay for those

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higher returns, whether it's through things like fees or whether it is

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through things like liquidity, but most certainly

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that can be suitable for an investor of that type.

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On the flip side, If you are a retiree or

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someone that's getting closer to retirement, as you mentioned, maybe

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you're someone that has a higher need for

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cash flow within your portfolio, maybe you're someone that is a little bit

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more risk-averse. Well, guess what?

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There's options out there in terms of alternatives that

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can potentially produce more income for your portfolio based

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on the different techniques or portfolio manager approaches that

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can be utilized.

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There's also options out there that use different

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measures to potentially dampen volatility or reduce correlation,

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meaning the relationship between the big three that I talked

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about before, stocks, bonds and cash in your portfolio, and guess what, you

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don't necessarily have to lock your money away or

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sacrifice the liquidity aspect that I just alluded to in the prior

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example. That's a long-winded way of saying when

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looking at different types of investors I don't think it's like a red light,

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green light type of answer or question,

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for that matter. It's more so investors asking themselves,

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what's the best alternative for me?

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That's great, Rory, and you're piquing my interest here.

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I'm curious, if I were to invest in a liquid or alternative I can

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do that either through an advisor or directly with the asset manager.

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Could you compare and contrast the differences between those two avenues?

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For sure, and we just talked a little bit about it but I

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think that without getting into the minutiae

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of all of the different types of alternative strategies or funds

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that are available out there to investors

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I'll more so just be generic and focus on what I mentioned

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and what you were, I think, kind of hinting at there, which is the difference

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between a liquid and an illiquid alternative.

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A liquid alternative, as the name indicates,

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will typically provide investors with a relatively high degree of liquidity.

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All that means is that their ability to turn

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an investor's investment into cash, if

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they so choose, is fairly high.

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What that means in practice is that typically on

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a daily basis if said investor were to want to

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sell that alternative investment and receive cash

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from that sale, the manager has the ability to

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do it. There's plenty of liquid alternative solutions that are out there

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that cater towards different aspects

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of investor portfolios.

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On the flip side, there's what I would say are kind of liquid investments,

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or illiquid investments, and those are investments in,

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potentially, assets or strategies where it's a little bit more difficult, or

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it takes maybe a little bit more time to turn that investment into

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cash. A good example of that would be

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a private real estate type of fund that investors may

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wish to hold. There's a lot of benefits with potentially holding a private real

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estate fund, the difficult thing is that when you invest your

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capital with that manager, what they're doing is they're going out and,

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potentially, buying physical assets like buildings or

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shopping centres or you name it.

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As a result of that, as you can imagine, it's not so

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easy to necessarily sell that apartment

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building or that shopping centre overnight and then return cash to investors.

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Not to say it can't be done, it certainly can, but it takes a little bit

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longer to do that.

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When investors are shopping around or talking to their advisor about

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what is best for me, that kind of liquidity

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conversation or am I best suited to own something that

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is a liquid asset or am I a little bit more interested for

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a portion of my portfolio to own something that's less liquid, is certainly

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something that should be top of mind.

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That's very helpful, thank you for level setting that.

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You touched on fees earlier, I'm curious, I've heard lots of jargon thrown

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around in terms of various fee structures.

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Seemingly, these different types of alternatives have different structures as

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well and each provider maybe changes how they charge fees a little bit

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differently. How would you best summarize, if we can, how fees apply across

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alternatives?

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You made mention of the fact that there's just tons of variability out there.

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I think the stigma with a lot of alternatives is that they're really

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expensive, and there certainly are alternative strategies and funds out

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there that are more costly, in some cases for very good reason, relative

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to a traditional fund or investment that you might own.

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Also, especially with the advent of these more

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liquid forms of alternative investing, there are

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lots of options out there for investors if they want to

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pay something that is more comparable to what they

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would pay as a managerial fee for owning other assets

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within their investment portfolio.

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I think that probably the most kind of polarizing of

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all of them is the essence of a performance fee

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or an incentive fee, which sometimes can exist on alternative

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funds, not, I would say, all of them out there.

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Just to explain a little bit about how that works for investors,

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performance fee is essentially a fee that a manager would charge for

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meeting certain performance criteria within the portfolio.

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I think the best way to maybe illustrate that for folks

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is to try and give a little bit of an example.

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The thing that comes to mind first and foremost for me is

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like going out to a nice restaurant for a nice dinner.

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It's the same kind of thing that investors think

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about when it comes to comparing the value or quality

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of something relative to the price that they actually pay for it.

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Using our dinner example, if I go out to a nice restaurant

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for dinner and the food's great and the ambiance is really

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nice and the service is 10 out of 10 then

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guess what? I'm happy to pay a higher price for that.

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But if I go to that restaurant a week later and

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for whatever particular reason the food wasn't very great or

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my service was really slow or it was

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too loud in there or for whatever a particular reason, you're probably less

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inclined to go back and pay that price again for

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that same service that you're being provided.

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Now, it just so happens in this instance it's a little bit more sensitive

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because it's your investment but, again, the assessment from

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a consumer's perspective of what am I

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willing to pay based on the value or the quality that I'm getting out of it,

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it carries over to this form of investing as well.

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You're saying you're willing to pay more for a better experience.

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Exactly. That's the simple way to sum it up.

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Maybe not everyone out there is.

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Maybe some people look for, going back to our dinner example, maybe

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they look first and foremost at price but I think that

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you'll find a range of individuals out there that

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may take either end of that argument and hence why,

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as I mentioned, it's a little bit more polarizing, but certainly

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if the value is there for investors I think that those fees can be

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justifiable.

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For sure. Thank you for that, Rory. You mentioned stigmas earlier.

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There were a few that came to mind for me when it comes to thinking about

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alternative investing, the first being that they could be very risky.

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Secondly, maybe you mentioned transparency, that it might be hard for the end

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investor to know really where their money is going and what's being purchased.

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Then the final one being that are these alternatives really just meant for

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ultra-high net worth investors?

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What do you think about that? Is that fact or fiction?

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Let's parse through each one just briefly.

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You mentioned first kind of the risky aspect of it.

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Certainly not.

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There are a full gambit of opportunities for investors

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out there with an alternative. Some are certainly more risky, they may come

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with unique risks relative to what they experience in their

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stock or their bond portfolio but there are plenty of options out there

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for investors that are lower down the risk scale if you're

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kind of defining risk by the volatility or the amount that the

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investment moves around.

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The second thing that you mentioned was transparency or a lack thereof.

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I think maybe over kind of 10 years ago, if you were to go back

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that's a fair argument.

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I think it's less so now.

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I think that a few things are changing that.

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One is the amount of competitive pressure that's occurring out

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there. We talked earlier about the fact that mainstream

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media seems to be talking a little bit more about alternative investing,

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especially for the end investor.

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Well, guess what? What that does is it puts pressure

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on the manufacturers of these products or

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the asset managers, like the Fidelitys of the world, to make sure that

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we are delivering that service and that transparency as best as

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possible to investors.

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Nowadays with, as I mentioned, especially after the

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advent of the liquid alternative options that are out there, and even with some

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of the less liquid alternatives, transparency has certainly

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improved dramatically over the course of the past 10 years.

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The last point that you made there was in relation to this really

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only being an area that's accessible to very affluent

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or ultra-high net worth or institutional types of investors,

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and that's simply not the case anymore.

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I think that the financial industry over the course of

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the past little while, in particular, have made a lot of strides

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in terms of creating products,

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creating different vehicles where investors of all types can access

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these things and they don't necessarily need to pay an arm and a leg

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in order to do it.

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Going back to something that we talked about previously, just that question of,

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you know what, which alternative is best for me.

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If I were to give folks at home a piece of advice,

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if you work with an advisor ask them that question, is an

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alternative type of product based on what I'm currently invested in,

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is that the type of thing that we should potentially talk about, and, if so,

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what's the best option for me because there are so many different types

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of strategies, funds, products that

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may improve investor experiences and, hopefully, improve

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goals for investors over whether it's the short, medium, or longer term.

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Thank you for that, Rory, and the advisor is the expert in terms of all things

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alternatives here. We appreciate your expert insights from Fidelity today as

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well and thank you to our viewers for joining the show today.

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You can find more investor content from Fidelity at fidelity.ca under

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the investor education section.

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upcoming live webcasts.

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Thanks for watching and I hope you'll join us again on The Upside.

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I'm Lauren Gardy.

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The Upside: Demystifying alternative investments – Practical insights for modern portfolios