Alternative Investment Strategies

April 30, 2010

By Chris Dardaman, CPA, CFP®, CIMA®, CAIA® 

Alternative investment strategies have been around for decades, yet have historically comprised just a small portion of the investment world. Most investors still only use stocks and bonds in their portfolios. Alternative Investments is a broad title used to describe a wide range of investment strategies, whose overall purpose is to provide returns that are not directly correlated to “traditional” investments like stocks and bonds. The bull market from 1982 to 1999 limited the appeal of alternative investments, keeping the industry very small. The 2000-2002 bear market helped many investors re-focus on the need for investment returns that were not tied directly to the stock market. Beginning in the 1990s alternative investment strategies started to become more widely used by innovative investors like David Swenson, Chief Investment Officer of Yale’s Endowment Fund. Yale’s investment success along with excessive stock market volatility helped spur the rapid growth of alternative investments over the past two decades.

Brightworth partners first began using flexible asset allocation managers for clients back in 1992 and initially researched hedge funds in 1997. After using some Alternatives managers and much due diligence over many years, in 2004 we added Alternative Investments as a separate major section of our client portfolios. We wanted to have a portion of client portfolios that would moderate some of the equity market volatility, yet still produce attractive returns. Over time we believe skilled Alternative managers should complement the stock and bond allocations, produce risk/return characteristics somewhere between stocks and bonds, and further diversify client portfolios to help create more consistent returns. The table at right gives a brief description of some of a wide variety of strategies that Alternative managers may employ (not all used by Brightworth). While Alternative investments have many positive characteristics, there are negatives including more complexity, higher costs, less tax efficiency, less liquidity and higher minimums. Historically, many Alternative investments have only been available through limited partnerships.  However, many of these strategies are now available in more liquid formats including mutual funds, ETFs, and separate accounts.

Strategic asset allocation is necessary to set the overall risk/return target for an investment portfolio over time, while tactical asset allocation shifts are important to maneuver through changing market cycles. The goal of our Alternatives strategy is to take advantage of opportunities and lower risk by investing in assets not highly correlated with stocks and bonds, and giving our managers flexibility. We believe a better way to make money over time and control volatility is to appropriately use Alternative Investment strategies as a portion of a well balanced portfolio. The widely used but seldom successful strategies of day trading and market timing are low probability approaches. If you have not made a tactical shift in the past twelve months, or are still only investing in traditional stocks and bonds, is your portfolio strategy outdated?