While corporations, consumers and governments are trying to get back on their feet following the global recession, continued volatility is pushing investors, especially high-net-worth investors, to pour their money into alternatives, which allow for broader diversification, said Gurinder Ahluwalia, president of Genworth Financial Wealth Management, at a media roundtable on diversification and new asset classes in New York City on Tuesday.
“We are several years into a multi-year de-leveraging process,” said Anne Lester, managing director and senior portfolio manager with J.P. Morgan Asset Management’s Global Multi-Asset Group. “It’s been painful and will continue to be painful.”
Especially for consumers, she said. While corporations have seen a V-shaped recovery, with corporate profits back to record levels, consumers still have further to go to regain confidence and recover fully. And governments have the furthest to go in the de-leveraging process. To pay down debt governments have several options: austerity measures, which are seen negatively by the markets; inflation, which is viewed even more negatively; and writing down debt or repudiating debt altogether, which Lester doesn’t see as a possibility.
“All of this can cause a huge problem for the financial markets for the next three to five years,” Lester explained. “The forecast sounds gloomy.”
It is in times like these, with volatile markets, that alternatives are critical because alternatives can help manage volatility in portfolios.
“With a volatile market, investors need to better understand true diversification, specifically the allocation of assets across different asset classes,” said Ahluwalia. “The conditions over the last few years have proven that traditional approaches may not be enough and that there is a need for investors to employ new strategies, potentially including alternative investments.”
The challenge is that even when advisors think their clients portfolios are diversified, they often aren’t. In an increasingly globalized world, diversifying a portfolio by including both international and domestic equities is not sufficient. Adding managed futures, an investment with a historically low-correlation to stocks and bonds, are better.
“How do you get true diversification when each asset class has increasing correlation?” asked Jon Sundt, CEO and president of Altegris Advisors. “Commodities, equities, and REITS are highly correlated,” so during the economic meltdown all of these asset classes got hit. Asset classes that did well were those not correlated to stocks and bonds, such as, managed futures, global macro investments, and long/short equity investments, Sundt said. “If you achieve true diversification, modern portfolio theory truly worked,” he added.
Yet studies show that advisors don’t use alternatives because they don’t understand them, Sundt said.
And they are difficult to sell to investors because although the losses are lessened with alternatives, so are the gains. “When we think about alternatives we’re not trying to generate higher returns, we are trying to stem volatility,” said Lester.
Genworth revealed that its top-performing advisors report they allocate over 27% of their overall portfolio toward alternatives. Meanwhile, 52% of advisors believe that assets under management growth in alternatives over the next five years will be greater than 10%.
“In three to five years, alternatives won’t be considered alternatives. They’ll just be considered regular,” said Sundt. “They’re regular in the institutional marketplace. Then they became regular in the high-net-worth marketplace. Soon they’ll just be regular for everybody.”