What is alternative investing?
Photo: Dave Meier. Source: Picography
Alternative investing is investing in something other than traditional stocks, bonds, and cash. It can include real-estate, commodities, precious metals, or collectibles, like art and wine. Its appeal is their lack of correlation with the major asset classes. If these assets rise in price but zig when other things zag, they can reduce a portfolio’s risk while still contributing to its return.
At least, that’s how it’s supposed to work. The problem is that alternatives are subject to the same biases and boom/bust behaviors as other assets. In the middle of the last decade many institutional investors added oil to their portfolios as prices climbed through 70, 100, and 125 dollars a barrel. There was concern that investors were buying up all the supplies and wouldn’t leave enough for the economy to run smoothly. Goldman Sachs predicted prices would top $200. Oops.
Brent Crude Oil Prices. Source: EIA
Those investments turned out to be correlated to most everything else during the financial crisis, and oil prices crashed. And when they recovered, they spurred new productive technologies like fracking and directional drilling that have contributed to the latest price decline. Buying oil in 2007 has turned out like buying gold in 1980—at least so far. After everyone jumps on board, it’s pretty hard for the boat to leave shore.
That’s why I’m skeptical of the current craze over liquid alternatives—ETFs and mutual funds that invest in theoretically uncorrelated assets. Because no vehicle can be significantly different than its underlying investment. If the economy contracts, wine prices and art and gold and private equity shares will contract with it. Holding these things in an ETF won’t protect you when there’s a rush for the exits.
There are only three ways to invest in an economy: stocks, bonds, and real-estate. Each represents a different level of claim on the economy’s cash flow. Everything else is window-dressing.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!