After 15 consecutive positive months the second longest bull market in history has exhibited signs of weakness early in 2018. It was bound to happen eventually and while the direction from here is anyone’s guess it is an ideal time to evaluate overall portfolio risk, an assessment that should no longer be limited to only stocks and bonds. While the concept of alternative investments rose in prominence in the 1980’s, the benefits and increased availability in the modern era makes alternative investments a viable option for any investor. When chosen prudently, hedge funds, private equity, and other alternatives can add much needed diversification, downside protection, and enhanced returns even for conservative investors.
As stock portfolios continue to utilize low cost ETF’s and increase in correlation to both the market and each other, more institutions and endowments are turning to alternatives to boost diversification through uncorrelated asset classes. Even at many of these large institutions, the standard 70/30 or 60/40 stock to bond ratio has shifted to include at least a 5-10% allocation to uncorrelated assets. Much like owning a single stock vs a basket or mutual fund, having multiple asset classes can offset much of the risk associated with a typical portfolio. For example the Yale Endowment Fund, run by esteemed CIO David Swenson, regularly targets a 30% allocation to market-insensitive assets (i.e. not stock), currently, the fund is weighted heavier than standard to non-correlated assets given the extended bull market environment. As always, what is right for individual investors with unique needs will be unique to them, but the search for quality alternatives is currently at the forefront of the investing world.
While some media sources and financial advisers suggest that hedge funds and alternative investments increase risk, when taken in the context of an overall allocation, rather than by themselves, many find the exact opposite to be true. Uncorrelated assets are intended to perform well or avoid volatility when the majority of investments are experiencing a drawdown, thus creating a nice compliment to overall returns. Employing even a small portion of assets, the table below illustrates what capping downside can do to protect capital and reestablish profitability more quickly. While volatility of an individual vehicle could be higher than that of the overall portfolio it can still make financial sense and protect wealth when you need it most. Understanding which environments different assets excel in is the key to allocating properly and creating a complimentary portfolio.
A 10% allocation to an uncorrelated asset, which outperformed in the crash of '08,
when integrated with an annually rebalanced 60/40 Stock & Bond portfolio
Second only to the “Tech Bubble” spanning 1990-2000, stocks have experienced a historical expansion leaving almost no fear in their wake. This euphoria has kept investors very happy, in turn, offering little incentive to look alternatively for higher returns. If history repeats itself, the next five years will provide a differentiating moment for investments that have been almost blindly successful across the board.
That said, the alternative world has long been a venue for some of the financial world’s brightest minds to generate excess return and produce greater long-term return figures, it is often this factor that separates professionals from the masses. Due to advances in technology, for the first time in history investors don’t have to be affiliated with a massive fund or large financial institution to reap the same benefits enjoyed by the big guys.
Hedge funds and alternatives are no longer just for the uber wealthy. There are over 10,000 funds in operation; many offering lower fees, minimums, and more liquidity to a wider base of clients. While multi billion dollar funds are more readily recognized, size doesn’t necessarily mean success, with many smaller funds maintaining an edge by being more nimble and offering returns larger vehicles can’t. The scope of alternative investments has extended to encompass choices ranging from commodities, derivatives, foreign exposure, to hot trends like cryptocurrency. The sheer options available are daunting and many of the vehicles are complex but with stock investing becoming more of a commodity finding a good alternative or two that compliment a portfolio can be a great way to grow wealth faster, and protect that wealth when everything else fails to do so.
The best time to evaluate a portfolio’s health is while waters are calm, and now is a great time to consider incorporating alternatives to enhance stability across market environments. In a space where information wins the day, the worst question an investor can have is the one unasked, many of our clients came to us simply by asking their adviser “What will happen to my money if the market goes down?” If the only consolation offered is related to bonds, or worse a suggestion that such an event won’t happen or will be foreseen before it does, then you have need of a new asset class in your portfolio. Every investor’s risk tolerance and needs differ, but the one truth across the board is that minimizing downside and increasing upside is good for any portfolio. Consider that before the bull finishes its charge.
Past results are not indicative of future results. No representation is made that results similar to those shown can be achieved. Certain market and economic events having a positive impact on performance may not repeat themselves. The actual performance results experienced by an investor may vary significantly from the results shown for a number of reasons, including, without limitation, different investment periods, portfolio changes and different economic and market conditions. There can be no assurances that the principals will be able to navigate future market dislocations.
The returns presented within this document are prepared by Blackpier Capital LLC and have not been independently verified. This document is being provided to you on a confidential basis solely to assist you in deciding whether or not to proceed with a further investigation of the strategy. Accordingly, this document may not be reproduced in whole or in part, and may not be delivered to any person without the prior written consent of Blackpier Capital LLC. Certain information contained herein constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intent,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of the strategy.