Decoding: Myths in Alternative Investments

We love this quote by Blackrock,

“A lot of misunderstanding surrounds alternative investments. Some investors still think of them as high-risk, exotic funds reserved for ultra-high-net-worth individuals and institutions. However, the reality is that alternatives had a place in nearly every portfolio.” There’s a certain cloud of “unknown” that shrouds alternative investments, perpetrated by the longstanding myths that also live out there. Alternative investments is our specialty. Let’s break down these myths and get your investment brain on the right track.

 

Myth: Alternative investments are risky.
Reality: Yes, they are risky – just like stocks and bonds, and every other investment. Just like any investment (check out this infographic that shows how asset classes react during crisis periods), there are periods of underperformance and over performance. But the statistics show that broad measures of alternative investments can show better risk adjustment performance over time, even when it’s not so obvious in the short-term.

“Investors are drawn to the idea of investing in something that is unique and different; however the general investing public continues to perceive alternative investments as more risky than the traditional portfolio,” says Jeff Eizenberg, RCM Executive Director. “Our research suggests quite the opposite – that in fact, alternatives can act as a volatility reducer in a portfolio.

 

 

Myth: Alternatives are for the super-rich
Reality: There are over 623 mutual funds with minimums as low as the thousands of dollars range. Some of the best run and biggest hedge funds in the world are still the domain of the richest of the rich, requiring investments of 10s, if not 100s, of millions of dollars to access. But there’s also the ability to access alternative investment strategies via managed accounts, mutual funds, UCITs, and risk premia products at levels without a bunch of trailing zeroes. RCM actually has a really nice tool that lets you look at different investment portfolios and filter down based on minimum investment, track records, returns and more.


Myth: Alternative investments are underperforming traditional assets
Reality: The problem with saying hedge funds are underperforming the S&P 500 is that the grand majority of them aren’t even trying to beat the S&P 500 in returns, for any set period. They are trying to deliver better risk adjusted returns than the stock market, but that doesn’t make for as good of a headline.

The problem is, as more hedge fund-like products make it into so-called ‘liquid form,’ and more everyday investors have to access them, more websites and other portfolio tools which compare performance to stocks by default will be serving up the S&P 500 as the benchmark for the Alternative Funds performance. Basically, what we’re saying is they’re comparing apples to oranges.

 

Myth: Alternative investments are illiquid.
Reality: There are both liquid and illiquid versions of alternative investments. For example, a private equity fund that not only doesn’t let you out for a few years, but can call on you to add capital in the future….that’s for sure an illiquid alternative. But, with managed accounts becoming more and more prevalent in the alternative space (they’ve always been a big plus in the managed futures space), the days of gates and lockups and illiquid alternative investments are fading somewhat. And you’re accessing your alternative investments through a mutual fund or UCITS, you’re looking at liquidity in a day +/- time for settlement. A managed futures accounts – you’re talking hours.

 

Myth: Alternatives go up when stock markets go down.
Reality: Those in the alternative investment space have long trumpeted the power of alternative investments (and particularly managed futures) to perform in a stock market crisis (see our evidence of that here and here). And some people have recently changed their tune. But what we’re finding is that the fact that alternatives are losing money at the same time as stocks is a prime example of the confusion between non-correlation and negative correlation. Most of us incorrectly conflate negative correlation with non-correlation, but the reality is that non-correlations just means sometimes positively correlated, sometimes negatively correlated.

We mentioned in our 2018 Managed Futures Outlook to beware the managed futures programs who may have ‘cheated’ a bit over the past few years by adding more short vol and long equity exposure. The last thing you wanted to do in the stock market sell offs the past few years was get out of your long position. The sell offs were short lived and quickly reversed, teaching any manager (or machine using AI) that it is better to space out exits and not do a knee jerk reaction to down moves. It’s more than possible that the resulting performance profile has become capturing more stock downside, even if the name on the door still says alternative investment.
TL;DR: Non-correlation isn’t the same as negative correlation. And, when you’re in a long/short equity fund, guess what, you have equity exposure.

 

Have any more questions on the elusive alternative investment? Give us a call (855-726-0060), or send us an email, we’d be happy to chat! And we’re always touching on alternative investments in our blog, subscribe here for more content.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

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