Unravel Alternative Investment Myths
Lack of knowledge is the top reason for not using alternative investments followed by lack of track record. As popular of an investing tool as they have become, there are different theories about what role alternatives play in a portfolio as well as what actually constitutes an “alternative,” so it’s easy to understand why there could by some misunderstandings.
To help set the record straight, a number of experts weighed in on some common misconceptions. Alternative managers noted some of the unfair biases they hear, and Kate Warne, the chief investment officer of Edward Jones provides a third party perspective from a firm known for its traditional approach to investing.
“We’re not 100% negative on alternatives, we’re just a lot more cautious about value and the role they play in a portfolio,” Warne said.
Since he is working on developing alternative products, we’ll use a definition provided by Ed Egilinsky, the head of alternative investments at Direxion, which is, “anything outside of long only stocks bonds and cash.”
Click through for a rundown on the top myths and misconceptions:
BUSTED: Many investors are dissuaded by the perception that alternative fund managers are “day traders,” Jeff Montgomery, the CEO of Al Frank Asset Management, said. His firm designs tactical ETF strategies and makes “material” rebalances in the portfolio on average eight times a year. That may be more often than some investors roll in and out of a position, but Montgomery said that their moves are all “methodical” (they’re made by a team of specialists holding Ph.D.s) and generally only occur around major global events.
BUSTED: Alternative managers take pride in the fact that their assets are non-correlated, which means that a drop in the S&P 500 does not mean their funds will do poorly. Montgomery, for example, takes pride in the fact that one of AFAM’s tactical ETF funds was up 2% in 2008. But as some pundits predict the economy to improve in 2013, investors may be wondering about the flip side.
A rising market doesn’t necessarily mean a drop in alternatives, Montgomery said. If the markets are doing well, his team can rebalance portfolios to capture that growth. However, because they’re used to diversifying and hedging against turns in the market, they’re generally only capturing 60% to 70% of the market upside, Montgomery said.
It’s important, however, to make sure your alternative manager has a track record in both up and down markets and knowing, “Are they truly experienced in going long AND short the market,” Andrea Trachtenberg, chief marketing officer at Altegris Advisors, said.
Cole Wilcox of Longboard Asset Management (which deals heavily in managed futures), said that some strategies can even top market growth.
“Also, the misconception is … that means you will by definition have to "under perform" [sic]
the stock market when the stock market is on fire to the upside,” he said.
BUSTED: Institutional investors have been interested in alternatives for some time as part of a capital preservation strategy, according to Egilinsky. But technically, they’re open to anyone. Montgomery targets the mass affluent (which he defines as invetors with at least $1 million of investable assets). Thanks to some lower regulations in the alternatives space, managed futures and hedge fund products are now available through mutual funds and ETFs, which have lower fees.
BUSTED: The corollary of the last slide is not true, according to Kate Warne, chief investment strategist at Edward Jones. Alternatives do not belong in every investor’s portfolio.
“It’s certainly possible to build a well-diversified portfolio simply using stocks and bonds and cash as investors traditionally have done,” Warne said. “Most investors goals with their money are long-term and moving it around a lot is expensive, but doesn’t add long-term returns.”
For investors looking for that added diversification, Warne suggests only small amounts of alternatives. Edward Jones, for their part, does not sell or recommend and long/short funds.
“They’re designed to address a particular concern or set of opportunities,” Warne said.
BUSTED: “There are many things that are called alternatives that simply are designed to sound attractive, but don’t always work,” Warne said. “Some things that sound like alternatives are not.”
“It is important to recognize that certain alternative strategies might have different risk/return characteristics. This means that certain alternatives and their appropriate percentage allocations depend on the individual investor’s risk profile. In a number of cases, some alternative strategies have a low correlation to each other as well as to stocks and bonds. This is why investment firms’ asset allocation models recommend allocating across multiple alternative investment categories.”
Lack of knowledge is the top reason for not using alternative investments followed by lack of track record, according to Cambridge, Mass.-based consulting firm Cogent Research. As popular of an investing tool as they have become, there are different theories about what role alternatives play in a portfolio as well as what actually constitutes an “alternative,” so it’s easy to understand why there could by some misunderstandings.