Alternative Context

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Barron’s had an article about alternative strategies over the weekend that attempted to sort out whether the traditional mutual fund wrapper might be better than the ETF wrapper for this segment. There was a comment that I found to be very interesting as follows;

Huh? 3.9%, 2.4%, and they are proud of that? I can buy a Pimco bond fund and beat those returns by 50% with no stock risk. Still not sure what the lure of 'alt' funds are. Since inception, they have been universally bad.

I believe this is absolutely the wrong way to look at alternatives. This is a point I have made many times before but alternatives are for providing diversification against extreme market events like the stock market cutting in half or if there is ever a comeuppance in the bond market for years of shockingly low rates.

Looking backwards, yields have trended lower for decades providing strong returns beyond the coupon. While equity returns have been poor on an annualized basis since the peak of the tech bubble, they’ve been very strong for other select periods like since the March, 2009 low. Even the last ten years, the S&P 500 is up 67% on a price basis, more if you throw in dividends. Anyone who was close to that and had an adequate savings rate and didn’t panic out in 2008 has a lot more accumulated in that time.

Looking forward it is very likely that equities will continue to repeat the bull and bear cycle, so investors who continue to be close to the market, maintain an adequate savings rate and don’t panic the next time the market cuts in half will likely have a lot more accumulated in their future.

Alternatives don’t offer that potential, at least not reasonably speaking. You won’t get 67%, plus dividends, in ten years from an absolute return fund that seeks CPI plus 2%.

Also looking forward for the bond market, if that comeuppance ever occurs it could be long and painful and strong returns beyond the coupon will no longer be available. There is no historical reference for how such low and negative yields resolves but it is an easily identifiable threat and if this line of thinking resonates then you might want to address it and alternatives are a way to do it. If this line of thinking doesn’t resonate then you probably have nothing to address.

Putting it in terms I’ve used before, alternatives are diversifiers. For many investors, their equity portfolio is where their growth will come from with bonds as a ballast to equity market volatility. If rates do go up, then bonds will not so easily offset equity market volatility. Further, if your diversifiers/alternatives are your best performers, then chances are things aren’t going well in the rest of the world. Alternatives hopefully offer diversification from both equities and fixed income.

No one should want alternatives to outperform equities and if the ten-year Treasury Note Yield goes to zero and then goes -1.0% and so on, then I would expect alternatives to continue to lag bonds and if rates ever rise then I would hope there would be plenty of alternatives that would avoid interest rate sensitivity and offset bond market declines.

Again, that either interests you or it doesn’t.

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© AdvisorShares

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