If Brian Jacobs were talking to a young graduate today, he might have just one word: alternatives.
Jacobs was hired last month as CEO of Hatteras Funds, an alternatives investment provider that specializes in working with financial advisors. And he sees alternatives as being a hot area now for both advisors and their retail clients.
Jacobs has spent most of his 26-year career in asset management at Eaton Vance and Allianz Global Investors, where he gained experience with alternatives. And now, post-meltdown, he thinks retail investors will be clamoring for these types of investments because of their low correlation with stocks and bonds.
After the meltdown that began in late 2008, the whole notion of modern portfolio theory came under heavy scrutiny. After being used as the basis for portfolio construction for more than 50 years, it was suddenly inadequate in explaining what was happening. (In a nutshell, not every investment was supposed to fall simultaneously.) Articles abounded declaring modern portfolio theory dead—including a few in On Wall Street.
But Jacobs says the underlying principle is still sound. That is, if you add the right mix of investments (even those that are riskier by themselves) you can lower the overall risk of a portfolio. He notes than when modern portfolio theory was introduced in 1952 it was a matter of mixing just stocks, bonds, and cash. But now, investors are more interested in adding alternatives due to that low correlation. “By adding these strategies with long-only investments, you can get a better portfolio... long-only and alternative investments are coming together fast,” he says. He says the environment has a feel similar to the early days of separately managed accounts, with a lot of investor interest and advisors trying to educate themselves.
Indeed, when looking at data from Morningstar, you can see an increase in the money being pumped into this asset class. Morningstar tracks 190 alternative funds, which have seen a 78% increase in assets in just the past 12 months. (Never mind that the median return in that 12-month time period is -6%.) By far the biggest fund in this universe, as tracked by Morningstar, is the PIMCO Commodity Real Estate fund [PCRIX], which has $17 billion in assets, up from $8 billion last year. The next biggest is Hussman Strategic Growth fund [HSGFX] at $5.5 billion, up from $4.8 billion a year ago. Those two finds returned 15.7% and .67%, respectively, in the past 12 months.
One of Hatteras’ most popular offerings currently is a fund of hedge funds Alpha Hedged Strategies [ALPHX]. It has $289 million in assets and posted a return of 11.95%, according to Morningstar’s data.
Jacobs says the challenge of his job is educating financial advisors on alternative funds. Many of them have not worked much with this type of investment. And their challenge, in turn, is talking to clients about alternatives and then really getting alternatives into a portfolio. In that vein, Hatteras has 20 people on staff to help FAs integrate alternatives into clients’ portfolios, he says.
So investors are more interested in this asset class. And your job now is to get yourself educated in the ways of alternative investments. How do they work and how are they best integrated into a portfolio? It may well be the one area you’ve avoided in the past, but you can’t ignore it any longer. Now you have to get up to speed in order to talk to your clients about this possibility.