There’s a saying on Wall Street that alternative investments are Wall Street’s answer to the question, “Do you have an asset strategy that helps manage risks, offers equity-like returns, and is off the beaten path?”
That’s what alternative investments (think solar, wind, market neutral, futures commodities, hedge funds, and real estate, among other asset classes) bring to the table.
No doubt, alternatives are big business these days. McKinsey & Co. estimate the total size of the alternatives market at $7.2 trillion, with an annualized growth rate of 10.7%. That’s double the market size since 2005, and twice the growth rate of traditional investments.
Another report, this one from Price Waterhouse Coopers (PwC) estimates that alternatives will grow in size to over $13.6 trillion over the next five years. “Alternative asset management will undergo a transformation in the years to 2020 and beyond as it adjusts to a new operating and economic environment and moves toward center stage,” PwC wrote.
The End Game For Alternatives: Opportunity and Value
By and large, alternatives combine higher risk, higher return (relative to traditional investments like stocks) investments, professional management and, most importantly, have a low correlation to “old school” asset classes. This low correlation creates significant portfolio benefits through diversification (risk reduction) and return enhancement.
The end game for alternative investments is straightforward: to capitalize on market inefficiencies while neutralizing the overall direction of the capital markets and interest rates.
Risk management is a mainstay with any alternative investment fund.
“Broadly speaking, the rationale for incorporating uncorrelated assets—those that behave differently for a given economic or market event—is that they may reduce overall portfolio risk and improve risk-adjusted performance,” American Century reports in a white paper on alternative investments. “This more balanced approach provides exposure to a number of different asset classes without leaving investors overexposed to any single area or segment of the market. Indeed, diversification works on the principle that by sacrificing some absolute return potential, you may reduce the risk you take by spreading your investment across asset classes.”
Your $100,000 Alternative Investment Portfolio
With risk management and diversification in mind (as well as appreciating asset value,) let’s build our own alternative investment fund, using $100,000 as seed money.
We’ll start with several different asset class categories: precious metals (gold), natural resources (oil), U.S. real estate investment trusts, emerging markets debt, currencies and hedge funds.)
$15,000 – Merk Hard Currency Investor (MERKX) $15,000 of $100,000 Portfolio – (-) 2.02% One-Year Return – This fund, with $117 million assets under management, seeks to profit from a rise in hard currencies relative to the U.S. dollar, according to SEC filings. “Under normal market conditions, the fund invests at least 80% of the value of its net assets (plus borrowings for investment purposes) in “hard currency” denominated investments,” the fund’s prospectus states. “The fund normally invests in a managed basket of hard currency denominated investments composed of high quality, short-term debt instruments, including sovereign debt, and indirectly in gold and gold-related securities. The fund is non-diversified.”
$10,000 – Guggenheim Managed Futures P (RYMFX) ($10,000 of $100,000 Portfolio – 10.6% One-Year Return – This Guggenheim fund is selling for $22 per share and has over $220 million in assets under management, in the managed future category. The fund seeks to achieve absolute returns,” the fund’s prospectus reports. “The advisor intends to invest in multiple proprietary and third-party investment strategies that seek to identify and profit from upcoming movements in any combination of global fixed income, currency, commodity, or equity markets. The fund will invest at least 80% of its net assets, plus any borrowings for investment purposes, in “managed futures.” It also may invest up to 25% of its assets in municipal securities.”MACROBUTTON HTMLDirect It has a “3” Morningstar risk rating;
$20,000 – ProShares Morningstar Alternatives Solution ETF (ALTS) $20,000 of $100,000 Portfolio – (-) 4.12% One-Year Return – ALTS is a good low-beta play, meaning it offers some stability in your $100,000 alternatives portfolio. The ETF tracks the performance of the Morningstar Diversified Alternatives Index, which allocates among a comprehensive set of ProShares ETFs that employ alternative and non-traditional strategies such as long/short, market neutral, managed futures, hedge fund replication, private equity, infrastructure or inflation-related investments, according to fund statements. There’s only $26 million in assets under management, leaving plenty of upside for investors, and offers an expense ratio of under 1.00% (at 0.95%).
$10,000 – Market Vectors Gold Miners (GDX) $10,000 of $100,000 Portfolio – (-) 24.72% One-Year Return – Gold certainly took a tumble in 2015, but 2016 could be a different story (gold prices are already up almost 4% early in 2016.) Following suit, GDX share prices have risen by 5.8% in value for the first week of 2016. This is a big-time fund, with net assets of $4.2 billion, and it offers commodity-minded investors access to brand industry names like Goldcorp, Inc.; Newmont Mining; and Barrick Gold. The fund is selling at $13.97 per share in early 2016, making the fund a good entry point into commodities, and a solid addition to your $100,000 alternatives fund.
$20,000 – ProFunds Consumer Services Fund (CYPIX) $20,000 of $100,000 Portfolio – 6.76% One-Year Return – This trading leveraged equity fund has $54 million in assets under management, and offers investors daily investment results, before fees and expenses, that correspond to one and one-half times (1.5x) the daily performance of the Dow Jones U.S. Consumer ServicesSM Index, according to the fund’s prospectus. “The fund invests in securities and derivatives that the adviser believes, in combination, should have similar daily return characteristics as one and one-half times (1.5x) the daily return of the index. The index measures the performance of the consumer services sector of the U.S. equity market,” fund document report. This fund is a durable performer, with 28.1% three-year returns, and 11% returns over the past 10 years. Investment fees are a tad high at 1.62% of assets, but it’s worth it to gain access to those steady returns.
$25,000 – Aberdeen Diversified Alternatives Fund (GASAX) $25,000 of $100,000 Portfolio – (-) 3.52% One-Year Return – We want a fund in our $100,000 portfolio that offers instance access to several alternative investment categories, and Aberdeen Diversified Alternatives Fund certainly fits the bill. The fund has $131 million total assets and a relatively low expense ratio of 0.52%%. This is a total return-oriented fund, and is built on a “fund of fund” platform, that seeks to meet its investment objectives by investing primarily in underlying funds and, to a limited extent, in direct investments, the fund’s prospectus states. The fund allocates its assets among a range of non-traditional or alternative asset classes to garner return from such non-traditional or alternative sources. It may invest directly in certain types of derivatives, for example, securities index futures or options, which may be used to hedge against a decline in the value of the fund’s assets, the fund reports.
An Alternative Approach To Portfolio Growth
As the number and quality of alternative funds grow, investors can expect to reap even more benefits of disconnecting from volatile stock markets.
If past really is prologue, expect alternatives to produce returns with lower risk correlations compared to traditional stock, bond and cash investments. That means stronger diversification and more robust risk-adjusted returns.
That should be music to the ears of investors looking for a different blueprint in 2016. For those market mavens, its alternatives to the rescue, with our $100,000 fund as a solid starting point.