Here’s a strong sign that the investment business is worried about a big market decline.
There’s growing talk from asset managers these days about the benefits of liquid alternatives as a complement to a basic portfolio of stocks and bonds. Liquid alts include commodities, real estate, infrastructure and derivatives. The pitch for adding them to a portfolio is to improve returns while managing risk.
“A 60/40 allocation to equities and bonds is no longer likely to be enough to offer investors the outcomes and diversification required to reach their long-term objectives,” said a recent media pitch about the coming Alternative Investment Management Summit in Abu Dhabi. “Alternative investments are increasingly critical to the investor’s portfolio.”
I disagree. The same things as always are critical to a portfolio – diversification between bonds and stocks from Canada, the United States and the rest of the world, low costs and an emphasis on rational thinking over emotions. Keep a long-term perspective of five or more years, don’t overreact to one bad year, add money when markets are down and avoid panic selling.
There are portfolio managers who can make a strong case for liquid alts, mainly by pointing out (correctly) that global economic and political developments are increasing hard to predict and understand. Stocks and bonds can both be hit hard, they argue. The solution: Hold assets that won’t follow the same up and down patterns as these traditional portfolio building blocks – that aren’t correlated, in other words. This is what liquid alts are supposed to provide.
If an adviser pitches a liquid-alt investment to you, hear them out. Maybe they can make a case that a small percentage of your portfolio belongs in this area. But my sense is that talk about liquid alts these days is mainly about sales, not science. Asset managers are worried that the long bull market will end ugly, as they always do. Investors are already jittery after the market plunge of late 2018. Another downturn could hurt sales of traditional investments and cause people to sell what they already own. Liquid alts offer a way to calm investors by holding out the hope of sidestepping the worst of the next market downturn.
The problem with liquid-alt investment products is that they are typically more expensive than conventional investments, and complex to manage. The strategies of liquid-alt funds recall the supposedly clever stuff hedge funds were doing when they were trendy back in the 2000s, before they met their match in the financial crisis.
Sad truth: A bear market is coming and investment returns are likely to be modest in the years ahead. To meet your long-term objectives, you’ll need to keep costs low, have significant exposure to stocks in addition to bonds or guaranteed investment certificates and, probably, contribute more to your investments. Liquid alts won’t save you.
Rob Carrick