The Use Of Alternative Investments In A Traditional Multi-Asset Portfolio

Ryan Hastie, CPFA® |

One of the unknown factors is where is social security going. According to the 2022 Social Security Trustee’s report, the program is expected to have to reduce benefits by 2034 if no action is taken. It is unlikely, however, that there will not be some type of reform or restructuring of the program and there are currently a few ideas floating around Washington. Historically, the government has been hesitant to take an entitlement program, such as social security, completely away from citizens. It is more likely they will reform the program to meet the needs of the people. Some of the scenarios that have been suggested are to lower payments to retirees, increase or eliminate the wage maximum, and increase the age at which normal retirement age occurs. It is likely that it won’t just be one of these scenarios, but a combination. While the simple answer is it is never too late to start saving for retirement, it can be overwhelming for some people. Starting late is better than having no nest egg or emergency fund at all. As always, consulting with a professional financial advisor is beneficial to review your entire financial picture and develop a plan that is designed to your specific goals and needs.

Total nominal return for U.S. stocks and bonds saw its worst year since 1871 per the Financial Times. U.S bonds suffered their worst year in recorded history dating back to 1794. Long-term U.S. government bonds saw their largest decline since 1788 according to Edward McQuarrie, investment historian and professor emeritus in the Leavey School of Business at Santa Clara University. Needless to say, 2022 was horrific for investors.

This past year saw a reversal of sorts. Over the past 21 years, stocks and bonds have moved in opposite directions, a phenomenon known as negative correlation. When stocks went up, bonds went down – and vice versa. Because of this, multi-asset portfolios have been comprised of a mix of stocks and bonds to minimize losses in a downturn in the market. However, in early 2022, the correlation between stocks and bonds changed to positive. This caused broad losses in both asset categories over the course of the year.

Now, more than ever, investors and money managers are looking for protection against future positive correlation in the stock and bond markets. One area that is gaining more popularity in portfolio construction is alternative investments. The term “alternative investment” generally applies to an array of investments that are distinct from traditional portfolio holdings, such as stock, bonds, and cash, according to Fidelity. Although there are several categories of alternative investments (alts), the more common types include hedge fund strategies, private equity, and real assets, among others.

Most hedge funds employ non-traditional investment strategies with the goal of generating returns that are uncorrelated with the stock and bond markets. These strategies include derivatives (e.g., options, futures, swaps), that because of their leverage (borrowing money), can amplify returns – both positive and negative. Some equity (stock) hedge funds employ market-neutral strategies. These funds seek returns uncorrelated with the underlying market index. Their goal is to deliver positive returns regardless of the current market cycle or economic landscape.

Private equity invests in companies that are not publicly traded on an exchange, such as the New York Stock Exchange. Although similar, private credit refers to loans made by non-bank or institutional investors. These investments are typically comprised of higher-yielding debt issues compared to corporate (public) or government debt. Lastly, real assets can include private real estate, commodities (e.g., precious metals, natural gas, oil, etc), collectibles, and fine art.

Although these are only a few examples of alternative investments, a more in-depth discussion with your financial professional will help determine which, if any, are appropriate for you.

*Investing in alternative investments may not be suitable for all investors and involves special risks, such as risk associated with leveraging the investment, utilizing complex financial derivatives, adverse market forces, regulatory and tax code changes, and illiquidity. There is no assurance that the investment objective will be attained.