Alternative Investments

Posted 10 Oct 2014 by Rick Irwin, CFP, CLU

Bloomberg news service reported on June 25th, 2014 that the world’s largest single investment pool, the Norwegian Sovereign Wealth Fund, which is worth $890 billion is “building up its organization and preparing for a move into infrastructure and private equity”. This follows in the footsteps of globally admired Canadian pension plans like Ontario Teachers and CPP which moved into these areas in meaningful ways years ago. The article states “The fund, which owns 1.3% of the world’s stocks, is struggling to meet a real return (net of inflation) target of 4%.” 

The fact that the world’s single largest pool of wealth is struggling to achieve its return objectives in today’s low interest rate environment reminds investors of the difficulties in investing in a risk-controlled way in a low-yield world. It also speaks volumes to the shift to alternative assets at the institutional level, and gives clues as to where “retail” (everyday investors like us) might look to similarly diversify their portfolios. In fact, alternative investments are growing at a faster rate then ETFs.

For years the primary investment decision put before investors was the relationship between stocks, for growth through capital appreciation and income through reinvested dividends, and bonds for income and stability. Simply put, if you wanted more growth, you held investment funds with holdings invested more in stocks and less in bonds and if you wanted to be more defensive the reverse was true. In an era where interest rates are so low and where conventional bonds will be negatively affected once interest rates do finally start to turn back up, this conventional investment allocation is in some cases producing less than stellar results.

Alternative investment funds invest in a wide variety of asset types normally found in the realm of pension funds and other large institutional investors. These include: physical real estate, commercial mortgages, options, closed end funds, private equity, precious metals and option writing. Collectively many of these strategies have become more recently accessibly through “retail liquid alternative funds” and John Harris, manager of the Dynamic Alternative Yield fund that invests exclusively in many of these strategies, recently stated that $233 billion in the U.S. is now held in these types of funds. “These funds are based on many strategies previously only available to high net worth and institutional investors.” Harris said. “This represents a significant opportunity. It is expected that these funds will see inflows of $1-$1.6 trillion over the next 5-10 years.”

These alternative investment fund strategies are all very different but in most cases they have two distinct similarities: a very low reaction level to stock market events and a majority of the returns coming from income generated by these investments, not from capital appreciation. In a world of chronically low interest rates these asset types potentially offer an opportunity to diversify away from stocks in assets that have much higher income potential than bonds.

Whereas the primary investment decision used to be how much to hold in stocks vs. bonds, due to these new income-oriented investment alternatives investors might change that to instead be a decision of how much to hold in investment funds that hold stocks vs. assets that generally don’t behave like stock in periods of market volatility. This is certainly the area that pension plans have gravitated towards. In Canada for example, the top 100 pension plans (by size) currently have between 15-20% of their assets in real estate and infrastructure and many more are moving in that direction, as shown by Norway. The Ivy League endowment funds (Harvard, Yale etc) are even bigger players in alternative assets. We should take cues from these pools of well-run institutional money and look to diversify our portfolios in a similar fashion, now that many of these strategies have become available at the retail level. It is a welcome change than we can show up to the job site with as many tools in our toolkits as the world’s most sophisticated pension funds to reduce risk and help grow returns.



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