Plenty of financial advisers say that you need alternative assets to create a truly diversified portfolio and improve your risk-adjusted returns.
Alternative assets include real estate, commodities, hedge funds, private equity and anything else outside the world of stocks, bonds and cash — even horses.
You can easily get exposure to real estate and commodities through real estate investment trusts, mutual funds, and exchange-traded funds.
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In addition to owning real estate, gold, or other alternative investments directly, investors have many choices.
Liquid alternative mutual funds and ETFs give you exposure to all kinds of alternative assets, deploying long and short positions, leverage, and derivatives. (Short positions enable you to bet on a price drop.)
“Liquid” means that the funds can be bought and sold daily, unlike many other alternative assets, which are relatively illiquid. One of the biggest liquid alternative ETFs is First Trust Long/Short Equity ETF. (FTLS) – Get Free Report As the name implies, this fund goes long and short stocks.
These stocks will generally move in the same direction as the assets they invest in.
Commodities like gold and oil do offer a hedge against long-term inflation. That means their values tend to rise when inflation rises, and their values tend to fall when inflation falls.
But it seems from observation that most alternative assets are simply a leveraged bet on stocks. When stocks increase, alternatives increase by more, and alternative assets decrease by more when stocks decrease.
When I broached that idea to the Harvard economist and former Treasury Secretary Larry Summers, he agreed.
Looking at mutual funds and ETFs, the return for alternative investments trails that of equity funds over the past 15 years – 12% annualized for stock funds compared with 4% for alternative funds, according to Morningstar Direct.
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Alternatives are more volatile than stocks, too. The universe of liquid alternative funds is small and doesn’t cover a lot of investments.
Over the long term, alternative investments should perform well because stocks perform well. For example, take Blackstone, the world’s largest private investment firm.
Its annualized returns for the past one, five, 10, and 15 years are 46.21%, 33.2%, 16.13%, and 27.02%, according to Morningstar. Those returns easily beat the totals for the S&P 500: 24.11%, 14.94%, 12.24% and 14.76%.
So you can definitely get some bang for your buck with alternative investments, but enhanced volatility can go with them. Leveraging stock-market gains is a good thing, but leveraging stock-market losses, not so much.
Bottom line: You don’t need alternative assets for diversification because they’re correlated to stocks. However, if you can stomach a lot of risk, there’s little harm in investing in alternative investments; just make sure it’s one of blue-chip quality.
The author owns SPDR Gold Shares and Blackstone shares.
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