Sound bites with sound investment advice.
The third-annual "Hedge Style Mutual Fund Forum" hosted by Van Eck Global on Oct. 28 brought together some of the liquid alternative industry's most prominent speakers, financial advisors, and fund managers. The event facilitated energizing discussion and left attendees with some thought-provoking words of wisdom.
"Hope Is Not a Strategy."
Financial expert and prolific speaker John Mauldin challenged investors to question the conventional method of investing and diversification--buying a portfolio weighted (by dollars) 60% in stocks and 40% in bonds and hoping it makes it through the downturns. Mauldin advocates incorporating alternative strategies to hedge against risk.
At the top of Mauldin's recommendation list are managed-futures strategies, which seek to profit from momentum across many different asset classes, for both their low correlation and attractive upside potential. Indeed, the proven ability of these strategies to zig when other investments zag makes them good long-term portfolio diversifiers. The average managed-futures hedge fund in Morningstar's database gained an average of 8.3% in 2008, when the S&P 500 lost 37.0%. Investors must temper their expectations, though, because momentum strategies, which require sustained upward or downward trends in various markets, won't always work. Their year-to-date performance, for example, is dismal (the average managed-futures mutual fund is down 5.7% through Oct. 31) due to frequent price trend reversals in many asset classes.
For those seeking greater downside protection, Mauldin proposes gold--he puts roughly 5% of his portfolio in it. Unlike many of the “gold bugs” out there, Mauldin views this commodity as insurance, not as an investment. A nontraditional market-neutral strategy could also work to temper portfolio losses. Market-neutral funds attempt to hedge out all market exposure by taking offsetting long and short positions, striving to provide small, but steady, returns in most market conditions.
In terms of portfolio objectives, Mauldin suggested investors will be lucky to achieve a 3% real return each year. That may not sound very impressive, but the logic is spot on--after accounting for the effects of inflation, a traditional 60/40 portfolio has returned only 0.89% annualized over the past five years, and the outlook for economic growth in developed markets is gloomy. Currency strategies, many of which take directional bets against the U.S. dollar, can provide an effective hedge against inflation. These funds also typically exhibit lower volatility than do other alternative strategies. Mauldin recommends income- or yield-producing strategies to achieve portfolio growth over the next decade.
"Why Would an Investor Want to Tether the Majority of His Portfolio to Something He Cannot Control?"
These words, spoken by Richard Bregman of MJB Asset Management, refer to the relative riskiness of long-only equity investing. Bregman likes alternative investments as a way to control and reduce the volatility (particularly on the downside) in his clients' portfolios. Bregman allocates at least 30% to alternatives, regardless of a client's age or risk tolerance. With this asset-allocation framework, he expects to capture 60% of the market's upside but only 30% of its downside.
Some investors and advisors might find themselves uncomfortable allocating 30% to alternatives. The Morningstar Barron's 2010 Alternative Investments Survey found that most financial advisors are allocating between 6% and 10% of their clients' assets to this space. A smaller alternatives allocation can still provide some welcome benefits, though. Allocating 15% to the average long/short equity fund, for example, from the equity portion of a standard 60/40 portfolio, would have improved an investor's risk-adjusted return (as measured by the Sharpe ratio) over the past three-, 10-, and 15-year periods (through Oct. 31). Adding one of the better long/short equity funds, such as Wasatch Long/Short (