Alternative Investments

Alternative Investments

Alternative investments seem to be a hot topic with many investment managers. However, I do not believe they are appropriate for most investors. Alternative investments include real estate, mortgage obligations, currencies, commodities and natural resources, art, coins, stamps and similar collectibles, liquor and wine, venture capital funds, hedge funds, leveraged funds, “liquid” alternatives, long-short strategies, sports teams and other exotic forms of investments.

A basic plan that I think works very well for most individuals would have them set aside rainy day funds and apportion the balance of their investable assets into equities and fixed income. This would provide a steady and somewhat predictable cash flow, reasonable asset growth and judicious safety.

It is my opinion that other asset classes are riskier and harder to understand and unless significant amounts are committed to those so called alternative investments it would have no material effect on the overall portfolio’s performance. By way of illustration, if 25% of the portfolio was invested in alternative investments and they out-performed the balance of the portfolio by 4%, it would have the net effect of increasing the overall portfolio performance by 1%. A rationalization by an investment manager could be that the 1% is a 25% increased portfolio return. However, in reality it is still 1% and by wanting to achieve that potentially greater yield the investor would be assuming a far greater risk than they might be comfortable with or would need. Also, alternatives do not always go up and the downside would yield greater losses.

There are more than 20,000 traded stocks but most fall into perhaps a dozen broad categories. There are also a dozen or so major mutual or index funds in each of those categories. Investing through these funds provide a degree of reduced risk bringing the investor closer to market risk while eliminating to a large extent management and specific company risk with reasonable transparency and almost instant liquidity. The risks in alternative investments are not as clearly defined or transparent and are usually more dependent on the managers and have reduced liquidity. Also, investing in stocks present challenges and sometimes choices that are not so clear – imagine the choices confronting you with the alternatives.

I have advised clients with virtually every type of investment over prolonged periods during good and bad economic stages and cycles. Clients’ reactions during bad times sometimes result in a shattering of their feelings of security with those that truly understand their portfolio’s components and the risks they assumed the least disturbed. While clients are not investment professionals most understand the generic risks of stock and bond investing. I believe the educational process and input needed for a client to fully grasp the totality of risks with alternative investments is outside of what most investors are willing to do.

It is my feeling that the asset allocation choices suggested in the second paragraph above represents a method that is appropriate to be considered by most investors and that alternatives do not present a viable alternative.