Alternatives: Exploration of Investing's Final Frontier
With stocks appearing to be entrenched in yet another consolidation phase, I thought it might be good to spend our time together this morning exploring one of the great debates in the financial services business at this time - alternative investments.
To be sure, the use of alternative investments in portfolios has become a very hot topic in the investment management industry as assets continue to flood into funds and ETFs that invest in things other than the traditional stock and bond markets.
The allure of using "alternatives" in one's portfolio is certainly strong. After the devastating bear markets seen in 2000-02 and 2008, investors couldn't be blamed for wanting to look outside of the traditional asset classes. And as usual, Wall Street was happy to create products investors wanted to buy.
As a result, alternatives are everywhere. Mutual fund companies have been rolling out alternative funds at a breakneck rate. Hedge fund managers have jumped into the fund business en masse. Heck, Invesco even launched an ad campaign entitled, "Goodbye 60/40. Hello 50/30/20" – a campaign which encourages investors to start putting 20% of their portfolios into alternative investing strategies.
The pitch is strong. "Alts," as they are called, are touted as a source of diversification, a way to create non-correlated portfolios, and a means toward potential risk reduction during severe market declines. I've heard some folks even suggest that alts are a way to produce a solid "riskless" returns!
The debate is everywhere. There are alt conferences. There are firms that specialize in alts. Everyone seems to want to get into the mix. And yet, many broker-dealer firms restrict the amount of alts an advisor can put into a client portfolio.
However, even amongst the financial advisor community, questions abound. What alts are best? When/where should they be used in portfolios? How much is enough? How much is too much? Are alts best suited as an alternative to bonds or are they an asset class unto themselves? Are the new-age alts a better way to go than the traditional alternative classes? And so on, and so on.
This has also been a frequent topic of conversation at our firm. Frankly, I'm lucky to have an alts expert on staff at Sowell Management Services. Mr. Chris Magann knows the space inside and out. In fact, in 2015, Chris met with 100 fund managers - the vast majority of which managed alt funds. As such, one of the first moves I made when I was appointed Chief Investment Officer at SMS was to put Chris in charge of alts. Next, I asked him to create two additional fund-selection alt strategies (Chris had already been managing an alternative income strategy for a few years), which he has dutifully managed for almost two years now.
I have definitely learned a lot about the space from Chris. But with the debate raging in the industry, I felt it was time to dig in and do some serious analysis of my own – away from the purveyors of alt products, of course. So, I have spent a fair amount of time recently looking at alternatives. Not just specific funds/etfs or products, mind you, but as an asset class in general. What I found was interesting.
What Exactly is an "Alt" Anyway?
Let's start at the beginning. Just what is an "alt?" According to Investopedia, an alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.
Investopedia goes on to note that most of these alt strategies are designed for sophisticated investors. "Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of the complex natures and limited regulations of the investments," the website says.
Yet today, these strategies are available in all shapes, colors and sizes – meaning a myriad of traditional open ended mutual funds and ETFs.
Having been in the business of investing other people's money for more than 30 years now, I have to admit that the topic intrigues me. I mean seriously, who doesn't want to own an investing strategy that is designed to produce a nice, steady 6-8% return without the vagaries associated with the traditional asset classes?
The question, of course, is how does one produce that nice, steady return in what is now commonly referred to as a low-return environment? I mean, if stocks are muddling along and bonds aren't producing much in the way of return, how do the alts do their thing?
Many of the pitches I've heard on these new-fangled alternative strategies are pretty amazing. While I'm being facetious here, these mean-reversion, counter-trend, managed blah-blah-blah strategies are designed to basically print money in all environments. They make money when stocks and bonds are good. And then they are also designed to produce results when stocks and bonds are bad.
How do they do it, you ask? By utilizing sophisticated trading strategies in commodities, futures, and options, of course.
One such strategy only invests when conditions are perfect. The managers then jump into their pre-determined "trade setup," make money as the trade unfolds, and then go home (back to cash). And what if they are wrong on the trade, you ask? No worries, we're told, they've got everything covered via hedges, stops, and more blah-blah-blah. Sounds perfect, right?
As you dig into the alt space, you will find that a great many versions of alternative strategies exist other than the traditional alts such as gold, commodities, and REITs. These new-age strategies include trend following, options writing, long/short equity, long/short credit, style premia, and merger and acquisitions arbitrage – or, well, anything else anyone can dream up.
The question of the day here is if these alternatives are living up to expectations. So, starting tomorrow, we will begin an in-depth exploration of reality in the alt world. Over the course of the next few days, we'll look at how old school alts differ from the new-age high-tech stuff. We'll look at performance of various types of strategies. We'll explore alts as a defensive vehicle and as an alternative to bonds. We'll look at when this stuff works and when it doesn't. The goal, in the end, is to see if the category lives up to the hype.
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the "Trump Trade"
2. The State of Global Central Bank Policies
3. The State of U.S. Economy
4. The State of Bond Yields
Thought For The Day:
"A positive attitude breeds success even more than success breeds a positive attitude." - Brian Wong
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.
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