Published August 14, 2013
Bond funds are bleeding value as the market adjusts to the end of quantitative easing and interest rates lurch back up to something like historical norms. But with a hit-or-miss earnings season raising hackles in the stock market, investors are searching high and low for places to put their money beyond conventional equity and fixed income instruments.
Unfortunately for those hunting that kind of escape route, most “alternative” assets – hedge funds, private equity, real estate and anything else you can invest in beyond stocks, bonds and cash – have generally been reserved for accredited investors with a lot of wealth, high incomes or both. The theory is that while a big institutional portfolio can benefit from a touch of exposure to these vehicles, a more concentrated dose can be deadly to a nest egg or other retail-level account if the asset class sours.
Even so, non-millionaires have been asking me how they can a shift a bit of money and capture some of the diversification advantage that would otherwise be restricted to ultra-high-net-worth investors. The good news is that there are publicly traded proxies for most of the major alternative asset classes. And in a world where even a slight hedge can have a huge impact on a portfolio’s long-term viability, the bits of allocation add up.
Easy does it. Although it may be tempting to pull your entire portfolio out of bonds in particular while the markets sort themselves out, it’s crucial to remember that these are wealth preservation vehicles, not high-performance wealth accumulators. Emerging wisdom is to allocate no more than 20% of your holdings to these vehicles, and a relatively conservative investor could do well with a lot less.
Yale and other top-tier university endowments rode heavy alternative allocations to returns that were only 2 to 3 percentage points above a vanilla stock/bond mix in the decade leading up to the credit crunch. Since then, they’ve actually trailed the conventional allocation by a similar degree – and the larger the share of the funds that were sunk in illiquid alternatives in the 2008 crisis, the worse the drag since.
Look at hedge funds’ performance this year for proof. Most of the hedge strategy indices that EurekaHedge tracks are trailing the S&P 500 by 13 to 15 percentage points, with only the funds that focus on Asia even coming close to logging half the broad market’s YTD return. Factor in the 2% annual expenses and 20% performance fee most funds charge, and you’re not getting a get-rich bargain at all here.
Still, the right hedge fund manager can uncover exotic opportunities from all over the world, take on leverage, wrap trades in options and other derivatives to maximize the upside and in theory leave mutual funds in the dust.
In practice, you can actually buy into mutual funds that invest in the most attractive hedge funds they can find, an approach known on Wall Street as the “fund of funds” strategy. Arden Alternative Strategies (ARDNX) has the highest profile, with holdings sourced from top-tier firms like CQS and D.E. Shaw. It’s a lot cheaper than buying into those funds on your own: minimum investment is $500 in an IRA or $1,000 in a taxable account, and the management fee is capped at “only” 2.5% a year.
Commodities have become popular as an inflation hedge and you’re probably already significantly exposed to the asset class through more conventional instruments like S&P 500 index funds, which typically have 14% to 15% of their assets invested in mining and oil stocks.
More direct commodity positions historically required a special brokerage account to buy or sell futures, but in the last few years a series of exchange-traded products have emerged to hold the physical assets for retail and institutional investors alike.
The broadest is probably the DB Commodity Index fund (DBA), which invests in agricultural commodities, industrial metals, gold and a substantial (60%) weighting to oil, gas and other fuels. On the other extreme, plenty of single-metal and –crop funds have hit the market, although as yet very few of them are anywhere near as liquid as the underlying commodity markets.
As yet there’s no wood ETF to replicate Yale’s famously timberland-heavy endowment, but ground-level investors can come close with a lumber REIT like Plum Creek Timber (PCL), which spun out of paper giant Georgia-Pacific to manage close to 8 million acres of Pacific Northwest forest. Beyond its diversification value, PCL also plays a current income role now with a healthy dividend yield of 3.6% after selling off with other REITs in May.
Speaking of real estate, the REIT is another “alternative” vehicle that gone mainstream in recent years. Hundreds of broad-based and specialized real estate companies and ETFs are available, and after a correction a few months ago many are on the cheap side. Like any other alternative, this should be a seasoning for your portfolio and not the sauce itself. For most retail investors, a stake in an indexed fund like the Dow Jones REIT SPDR (RWR) should be more than adequate, or look into the companies that provide services to the REIT industry like HFF (HF) and Jones Lang LaSalle (JLL).
Even private equity is no longer an exclusive asset class for ultra-high-net-worth investors only. You may not be able to buy into Bain Capital’s funds, but you can own shares of elite management companies like Blackstone (BX) and Apollo Global Management (APO) and share a piece of their behind-the-scenes expertise and financial success.
And if you’re excited about truly exotic investments, collectibles – classic cars, vintage wine, rare coins, fine art – these are also technically “alternative assets” and offer some of the diversification advantages of their more standardized counterparts.
That’s the good news. But before you rush to cram a comic book collection into your IRA, remember that there’s a big difference between investment-grade property and stuff you happen to find appealing. Evaluating collectibles takes money and deep knowledge of long-term market trends.
Unless you have both to spare, it may be better to keep the memorabilia out of your portfolio and investigate Sotheby’s (BID) as a proxy. Even though the company lost money last quarter, hedge funds still love its rarefied franchise and ability to generate cash. The chart is impressive; the future is anyone’s guess.
Hilary Kramer is the editor in chief of the subscription newsletters: Game Changers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return Portfolio and Inner Circle. Formerly, Hilary was the CIO of a $5 billion global private equity fund. She has an MBA from the Wharton School at the University of Pennsylvania and began her Wall Street career as an analyst at Morgan Stanley. Hilary is the author of The Little Book of Big Profits from Small Stocks (Wiley) and Ahead of the Curve: Nine Simple Ways to Create Wealth by Spotting Stock Trends (Free Press). To learn more about Hilary Kramer visit: http://GameChangerStocks.com.