Advisors and clients need to understand what they’re buying and the role a strategy has in a portfolio.
This article originally appeared in the June/July 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
The number of liquid alternatives offerings has skyrocketed since the 2008 financial crisis. Not satisfied with the performance of their traditional stock and bond portfolios, many advisors and investors have sought out the sophisticated strategies that hedge funds and institutional investors have been using for decades. Mutual fund and exchange-traded-fund firms quickly answered the call. The fund industry has launched hundreds of alternative offerings of varying strategies and asset classes over the past five years. To get a practical view of this burgeoning segment of the industry, we interviewed three professionals who have many years of experience investing in alternatives for clients.
Bradley Alford founded Alpha Capital Management in 2006, a registered investment advisor based in Atlanta. He is the portfolio manager of Alpha Opportunistic Growth ACOPX and Alpha Defensive Growth ACDEX. Richard Raby is a portfolio manager for Creative Financial Group, also based in Atlanta. The firm provides financial planning and investment advisory services for high-net-worth clients. Richard Bregman is the founder and CEO of MJB Asset Management, a RIA firm based in New York City.
The three will appear together June 13 at the 2013 Morningstar Investment Conference in Chicago.
Jerry Kerns: What is your definition of an alternative investment?
Bradley Alford: The term alternative investment is used to describe both asset classes and investment strategies. Alternative asset classes are those other than the three traditional asset classes, which are stocks, bonds, and cash. Examples of alternative asset classes are private equity, real assets, and commodities. Alternative strategies are those that use management techniques other than long-only, such as leverage and short selling. The term hedge fund is generally used to describe the vast array of alternative investment strategies. It’s worth highlighting that alternative investment strategies are implemented using traditional asset classes, as well as alternative asset classes.
Richard Raby: An alternative investment is any investment outside the standard, long-only investments in equities and fixed income. This would include precious metals, futures, short positions, options, and asset-allocation strategies that can use those same vehicles.
Richard Bregman: Alternatives are not investments per se, but rather are strategies that incorporate some element of hedging, whether through individual short sales or by use of derivatives, such as options, futures, swaps, etc. From this perspective, there are three categories of investments: equity (ownership), debt (lending), and insurance (short sales and derivatives). So-called long positions in equity and debt are typically referred to as traditional investments; alternatives incorporate that third category— insurance as a hedge against security, industry, and systemic risks. Alternatives by themselves are not an asset class. For example, from this perspective, a long-only commodities fund is a traditional equity portfolio in that you own a basket of stocks, metals, or contracts. Long-only REIT funds are traditional equity funds because you own positions in REITs. An emerging-markets bond fund is a traditional fixed-income portfolio because you are lending to emerging country governments or corporations. By contrast, a long/short commodities fund, or a long/short REIT fund, or a long/short emerging-markets bond fund is an alternative strategy, as the funds contain traditional positions in stocks and bonds but also contain short positions as insurance. Adding that third category—insurance— typically will reduce correlations with traditional strategies and reduce volatility relative to traditional strategies.