Alternatives: A Common Sense Approach

05/02/2012 1:00 am EST

Focus: ALTERNATIVE INVESTMENTS

Alpha. Core and Satellite. Modern Portfolio Theory. Correlation. It seems that the financial world has fallen in love with a whole new language. But is the point to drive smarter investments or just higher fees?

Well, let’s forget all the lingo and look at the facts. This one is key: the traditional 60/40 investment model is much riskier, and far less rewarding, than we’ve been taught. Over the past 110 years, an annually rebalanced 60/40 portfolio generates real annual losses about a quarter of the time… often, very large ones that can take decades to earn back. And while the classic mix has generated average returns of 4%, that math disguises the key fact that essentially all of the total gains came from just four decades. Real returns over the other 70 years averaged under 1%

So, the question is: do we think the next ten years offer an historically attractive environment for financial assets? It’s certainly hard to say “yes,” given the developed countries’ debt crises, glacial growth rates, and looming currency wars.  And in that environment, of course, even stuffing money into a mattress is a losing proposition.

That’s why alternatives can make sense. Intelligently used (and paid for!), they can generate better risk adjusted investment returns than traditional portfolios; provide inflation-protected income without duration risk and act as a platform for generational wealth transfer.

Now, better risk adjusted returns do not always mean better nominal returns. But because “hedged” strategies take significantly lower risks, they diminish the odds of large losses. (In 2008, the average hedge fund investors lost only about half as much as those in 60/40 strategies, and recouped those losses more quickly.) These types of strategies include global macro, market neutral, and structural arbitrage approaches, and are available through a broad range of investment vehicles.

Investors can also look to alternatives for income without the duration risk so prevalent in bonds and bond funds. Moreover, some vehicles, like MLPs, REITs, and certain closed-end high yield funds, also provide an inflation hedge (because revenues rise with inflation) and tax advantages.

Finally, in a turbulent world, alternative assets can serve as the best way to transmit wealth to future generations. Ironically, many great aristocratic families of the past maintained their status through war and regime change through what we’d now call “alternative” assets, like art, gold, and timberland. But private equity investments can also play a role.

With all this in mind, it’s time for an in-depth look at the world of alternative investing. That’s what we’ll do at The MoneyShow San Francisco. We’ll consider everything from alternative strategy mutual funds to registered hedge funds, and from direct seed investing to art. And, we’ll drill down on the vehicles, fee structures, and tax consequences that drive net returns. As you’d expect, we’ll have the top names from the industry there to explain everything you need to know about the alternative world, and how to make it work for you. Please join us.

Related Articles on ALTERNATIVE INVESTMENTS