Alice: “Where should I go?”
The Cheshire Cat: “That depends on where you want to end up.”
What does this have to do with investing? Many investors are asking where they should go today.
Global central bank reactions to the 2008 financial crisis have led to elevated levels in traditional stock and bond markets. By some measures, stock valuations are in the top 1 percent of where they have been historically.
Bond yields are at historic lows and negative in many parts of the world.
The good news is that some investors made a lot of money since markets bottomed in 2009. How much you made likely depended on your tolerance for risk and your asset allocation (or split between stocks and bonds such as 60 percent stocks/40 percent bonds, which is often considered a balanced portfolio).
The bad news is that when you start from a place of high valuations such as today’s, future returns will almost certainly be less than the recent past. Even worse, some studies suggest stocks and bonds both could have returns close to zero the next five to 10 years.
In that environment, your asset allocation to traditional investments doesn’t matter. Progress will be difficult.
Optimists might be tempted to dismiss these words of caution.
However, the job of an adviser is not to predict the future but rather to prepare to make the necessary progress regardless of whether the optimistic bulls or pessimistic bears are proven correct over a period of time.
So, back to the Cheshire Cat’s answer.
If you want to risk making no meaningful progress over the coming years, consider sticking with portfolios dominated by stocks and bonds and manage volatility with an appropriate asset allocation.
Or, if you are willing to try something new in the calculated pursuit of progress, jump into the rabbit hole, escape the traditional and explore the world of alternative investments.
Alternative investments tend to fall into a few categories such as private equity, hedge funds, managed futures, real estate and natural resources.
They are not guaranteed to make money. They can be illiquid, meaning you can’t always immediately get back your money.
They can have high internal fees, and they can complicate a tax return.
Some might even say this advice sounds like it’s from the Mad Hatter.
OPPORTUNITY TO BE TACTICAL
Yet, alternative investments tend to have a few characteristics that are really desirable, especially if the future is as challenging as some project.
Alternative investments tend to generate acceptable returns regardless of the direction of traditional stock or bond markets. They also frequently exhibit less volatility or risk than traditional assets.
There are a few reasons why these compelling characteristics exist, including:
< The illiquidity premium that investors demand for limited access to capital.
< Alternative investments often are backed by real, tangible things.
< The managers’ ability to be tactical and make multidirectional bets.
Of course, there is more to it than that. But if making consistent returns and sleeping well at night are interesting to you, continue down the rabbit hole.
One of the most successful investing track records of the last 20 years belongs to the largest endowment in the world, the $36 billion Harvard University endowment.
At the end of fiscal year 2016, Harvard’s asset allocation was 29 percent stocks, 13 percent bonds and 58 percent alternative investments.
In a March study by private equity pioneer KKR of New York, it was found that ultra-high net worth investors ($30 million-plus of investable assets) had portfolios that were 29 percent stocks, 25 percent bonds/cash and 46 percent alternative investments.
These allocations to alternative investments are not new and have been developed and refined for decades.
NOW OPEN TO THE AVERAGE INVESTOR
Ultra-high net worth investors and institutions such as Harvard used to have an advantage over the average investor.
Access to certain alternative investments used to be limited to those who could write a $5 million check. Fortunately, minimums have been falling and access improving for the typical investor.
An investor now can access some of the world’s most accomplished managers for as little as $50,000 if certain reasonable net worth or income requirements are met.
There are now alternative investment mutual funds with minimums of $1,000 and no meaningful suitability requirements.
There is no “right” asset allocation, as every portfolio should be determined after considering risk tolerance, liquidity needs, growth needs and tax status.
Furthermore, there is no “right” allocation to alternative investments.
It’s doubtful that a 58 percent alternative investment allocation such as Harvard’s is appropriate for an individual.
But in most circumstances, a 10 percent to 25 percent diversified alternative investment allocation is worth exploring, regardless of one’s bullish or bearish feelings toward traditional stocks or bonds.
Jason Cort of Center Valley is president and a founding partner of Quadrant Private Wealth, Bethlehem. His specialties include investment strategies designed to mitigate risk without sacrificing return, as well as liability management and estate planning services. He can be reached at firstname.lastname@example.org or 610-849-2740.