Consider the Alternatives (Conclusion)
So should alternative investments be part of your investment portfolio?
Ocean wave. Photo: Jon Sullivan. Source: PD Photo
Every investor is different, with different needs, hopes, and limitations. So it would be wrong to make a blanket statement about an entire investment approach. But with that caveat, there are a few enduring principles to consider.
First, be aware of what you are paying in fees. Most alternative structures cost a lot—and not just because the managers are greedy. Administration can be expensive, operations can be complex, and smaller funds—the ones with the best chance of success—can’t spread these costs out very much. Fees are a constant drag on your performance. They rarely go down.
Second, remember where wealth comes from. Wealth isn’t created by speculation and getting lucky, it comes from innovation and free exchange. The United States isn’t the wealthiest nation on earth because we are fortunate in our natural resources. We thrived because we have been the most inventive: settled by a self-directed group of men and women who wanted to use their minds and labor to create something new. So most people do well by having most of their money in stocks—where new approaches old problems can sometimes generate spectacular wealth—and growth for their investors.
Apple share price, 2001-2016. Source: Bloomberg
Third, diversification is only as valuable as you need it to be. If your approach to investing is “buy-and-forget-about-it,” then having some funds zig when others zag doesn’t add any value to you. Your best approach is probably to own the most broadly diversified equity index you can. It doesn’t make sense to pay for insurance you won’t use.
There’s no free lunch. Alternative investments create positive financial returns by participating in the global economy—either through alternative strategies or by intermediating shifts in production. That’s why oil funds did so well 10 years ago—strong growth in China was generating new demand. Now higher oil prices have generated new sources of supply. Alternative asset prices are uncorrelated because the whims of investor fancy shift around, sometimes without much warning.
And because sentiment is so important, it’s rare for a hot investment to enjoy outsized returns after everyone is talking about it. The time to buy straw hats is in the winter. Alternatives work best when no one is considering them.
Douglas R. Tengdin, CFA
Chief Investment Officer