A timely discussion about Alternative Investments
During the tumultuous red and green gyrations of the capital markets this year have your clients anxiously called to ask: “What’s going on with my portfolio?”
What do you do when the usually smooth ride in your luxury automobile becomes as bumpy as Mr. Toad’s Wild Ride in the Happiest Place on Earth? What does the average investor do?
Consider for a moment your car. When the road gets bumpy, it’s the shock absorber that helps keep your tires on the ground so that you, as the driver, can maintain control of the vehicle. That’s what they are designed to do.
It’s time to replace your shock absorbers if….
- It takes extra time to break and your car often nosedives when applying the brakes
- At high speeds the vibrations can be more intense, and overall control of the vehicle decreases
This sounds a lot like what is going on in the global capital markets
~Nosedive velocity in price advances and declines~
Over market cycles I have had the experience of owning true alternative investments (ALTs) like real estate LPs, first trust deeds, private equity and debt, managed futures, precious metals, and other multi-strategy assets. These types of ALTs can perform as a “Shock Absorber” for my portfolio when volatility strikes. Furthermore they can add value during times of low volatility.
What are “Alternative Investments”?
An alternative asset is basically any asset that is not publicly traded. Common examples are real estate, precious metals, private equity, hedge funds, commodities and more. Alternatives are commonly perceived as being most suitable for institutional or high-net-worth investors, but that isn’t always the case. Alternatives are becoming more mainstream and are accessible by many investors.
ALT investments are not “marked to the markets”
When your Bloomberg Terminal is ablaze in red, and the talking heads on the nightly news networks are reporting on the “Mega Meltdown”, “CrashZilla”, or the “End of the Bull Market” many alternative investments typically are priced the way they were at the start of the day.
Like the value of your home—it is always changing but you never know exactly by how much until you get an appraisal. This can help reduce the impulse to sell at the wrong time, only to regret your decision later.
Liquidity: How important is it to you or your client?
The “liquidity” inherent in more traditional investments like mutual funds and ETFs is not an attribute of most ALT investments. There are typically a finite number of available units for purchase at any given time. And the nature of the investment, for example being an investor in a first trust deed note paying 8% and maturing in 14 months, does not fit in the “liquidity” box. Nor does purchasing and holding physical precious metals, including gold, silver, platinum and palladium bars and coins. Being a limited partner investor in a commercial or apartment building is another example where liquidity and mark-to-market are not usually a concern.
There are times, and types of investments where “liquidity” and “Mark-to-Market” are just not relevant.
To further explain this, I would like to direct you to the article “Turning Conservative Investing Upside Down” by Tiger 21 that suggests long-term investors may want to look at risk differently, for example:
- Do not assume liquidity and safety are the same things
- Income generation may be more important than price performance
Part of what makes true ALTs the kind of “shock absorber” that may never find a place in the traditional mutual fund or ETF space is precisely what could them an attractive addition to a client’s portfolio—they are not marked to the market.
Although you might need to educate your clients on the subject, when it comes to diversification, if you’re not considering alternatives, you may not be doing all you can to help your clients achieve their goals.
And when talking with clients or potential clients, explain that alternatives can act as a form of “shock absorber” to smooth out the ride.
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