ARE YOU DIVERSIFIED? (REALLY?) -OR- IF U.S. EQUITIES CRASHED TOMORROW, HOW WOULD YOUR PORTFOLIO FARE?

By Kevin E. Meier, CFA

Diversification is a term so widely used, and so haphazardly applied, that is has mostly lost its meaning, or at least its gravitas among investors, even sophisticated and professional ones.  From Markowitz to Swensen to Tony Robbins (thanks mostly to Ray Dalio), the gospel of a well diversified portfolio has been preached from pulpits across the land, and while some investors have been rigorous in its application for decades, most of us, even those who know better, have not.

Think about your entire portfolio as it stands today, and how much of it is in equity or equity-like like assets, and therefore, how much of it is correlated to the stock market and/or the US economy. Stocks, ETFs, mutual funds, private equity, real estate, your job and business interests, and sometimes even bonds... what happens to them if the market crashes and we fall into recession? Do you have non-correlated equity or bond strategies, commodities or CTAs, or anything else that can perform independently?  When we take an honest look, we know the importance of owning such assets and strategies, but something keeps holding us back.

1.   First off, we have been told that holding Stocks for the Long Run is the best game in town.

2.  And that no one can beat the market, so the best we can do is 1. Set Goals  2. Develop a Suitable Asset Allocation (In Stocks and Bonds and Cash ONLY) 3. Minimize Cost  And 4. Stay Disciplined (Try Not to Re-Balance) (From Vangaurd's 4 Principles)

3.  Besides, aren't non-equity investment just a hedge to dampen volatility? So if the markets run, we would be missing out. (From Stanford School of Management, so you know it's good.)  Not to mention, Bonds don't help as much as you think.

4.  Which is all fine and good if all you want to be is average.  But the professional and institutional investors know that the Yale Endowment Model is thriving, and that hedge funds and other alternatives are critical.

5.  GMO believes that Now is the Time for Hedge Funds.

6.  In fact, a survey conducted by Altegris at its Strategic Investment Conference in May, 2015 found that almost 60% of Institutional Investors believe that alternatives should represent between 10% and 25% of a diversified portfolio, and that 15% believe the allocation SHOULD BE AS HIGH AS HALF. (Emphasis is mine)

7.  Interestingly, the reason that Calpers got out of Hedge Funds might be because they couldn't get enough exposure to move the needle. 

8. Currently, there are more options than ever for investors looking for access to alternative: with different strategies, structures, and fees.  

9.  And many well respected players are making the case for different forms of Alternatives in your portfolio:

From the WSJ The Case for Alternative Investments 

Allianz makes the Case on DailyAlts.

And Blackrock.

10. And so on.  Of course, there are Successes and Failures of Liquid Alts, and Liquidity, which is one of the major selling points of Liquid Alts, could be a problem.

11.  Which is one of the reasons we believe the SMA might be the best way to access advanced alternative strategies, as better hedge fund or mutual fund option: Separately Managed Accounts: A Mutual Fund Alternative

12. We may certainly biased, but we believe that alternatives, especially in the SMA structure can be A Boon for All who understand their value.

 

 

*Alternative investments can involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.