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When Stock and Bonds Become Overvalued, What are the ‘Alternatives’?
As you know, we have been recommending, and using alternative investments for many years. Alternative investments have been used for decades by large institutional investors to include pensions, endowments, foundations and the like. Historically, alternative investments within a portfolio of traditional stocks and bonds, have helped reduce risk while increasing return. This is why alternative investments are added to portfolios.
As traditional asset classes such as stocks and bonds have gone up in price over the past six years, so have their valuations. At some point, traditional stock and bond assets become overvalued, and one must look for ‘alternative’ investment ideas.
Simply put, alternative investments offer the investor the ability to diversify away from traditional asset classes (i.e. stocks and bonds) when those assets become overvalued. Historically, adding alternatives has helped increase return while lowering risk. Alternatives managers are able to profit from both rising and falling markets whereas this is generally not true for managers who invest solely in traditional assets like stocks and bonds. Hence greater diversification for the investor especially during down periods in the markets.
Over the past few years, namely 2011 through 2013, alternative investment returns were lower than their historical average annual returns. Having done very well during the 2008-2009 time period, alternative investments took a ‘back seat’ to both the stock and bond markets in recent years and lagged considerably.
Something Changed in 2014
During the middle of 2014 however, something changed with respect to global investor appetite for risk. During this period, alternative investments began to, once again, perform very well as measured in both absolute terms and as measured in relative terms to traditional asset classes.
If you would like to know more detail as to what changed during 2014, then please read our article published on Morningstar’s website March 25, 2015 ‘When Securities Diverge‘ for that information. Go here to read the article.
Many alternatives managers are ‘trend following’. This is to say the managers look for trends, regardless of the direction of such trends. Whether it is upward price trends or downward price trends, these managers invest accordingly in order to benefit from those movements. These managers quite frankly do not care about the direction of markets since they possess the skills and mechanisms to potentially profit in any market direction.
In the 2011-2013 time period, global central bank monetary polices (i.e. money printing) dampened and muted many historical trends alternative managers have benefited from. Ironically however, those same central bank policies that created much of the dampened performance of previous years, is now a key factor for much of the price movements that alternatives managers are benefiting from today, uncertainty.
What was also missing during 2011-2013 period was rapid price movements also known as volatility. We have a way of measuring volatility in the market via an index called VIX. When this index is high, investors are fearful signaling that we are closer to a near-term market bottom. Conversely, when that index is low, it signals that investors are confident, or stated more bluntly, investors are complacent which indicates we are closer to a market top. Presently the VIX index is hovering near record lows reflecting significant complacency within the markets.
Volatility is Back
We discuss the increased market volatility in our October 30, 2014 article ‘Living with Higher Volatility‘ also published on Morningstar’s website should you wish to learn more on this topic. Go here to read the article.
Below you will find a number of alternative managers we work with at Gratke Wealth, LLC and how they have recently performed.
Year-to-Date: Ending Q1 2015
12 Month Trailing: Ending Q1 2015
A view over the past trailing twelve months ending Q1 2015
Is There a Perfect Environment for Alternatives?
Well perhaps not, but alternatives manager do prefer trends created by price movement which are created from increased volatility. So are we headed into, or perhaps already in, the perfect environment for alternatives? Again we won’t’ say ‘perfect’, but the current environment is rewarding the astute alternatives manager with opportunities from increased price movements in the markets. Such recent trends include the significant declines in oil, lumber and the multi-decade strength in the US Dollar v.s. foreign currencies not to mention again, global monetary policies. Let us not forget alternative’s huge positive performance gains during the stock market crashes of both 2000 and 2008. See link below to view that historical information verses the broad stock markets.
When a particular asset class remerges from a multi-year period of under performance back to period of much improved performance, we cannot help but be reminded of this Warren Buffett quote:
“The stock market is a device for transferring money from the impatient to the patient.”
For the investor with holdings in alternative assets over the past few years, congratulations to you for being patient and staying disciplined to your investment philosophy and process. Today’s improved performance is the fruit of your patience and discipline. With global economic growth still uncertain, amongst many other factors causing uncertainty, we believe alternative managers will continue have many opportunities to capitalize upon as current trends persist or as new trends develop.
For additional information on alternative investments, please go to our learning page at http://gratkewealth.com/alternatives/ which includes historical performance for various alternative asset classes.
As always, thanks for reading, and we would be pleased to discuss this information with you.
Why the Bull Market is Toast, Published on Morningstar.com February 23, 2015 0 comments