Are alternatives right for me?
alternatives…
How do I know if they are right for me?
Like many things in life the answer to any question is often not black or white but rather a shade of grey. Investing is certainly no exception to this rule. Transparency of investment products may be clear at a high level but the details may be harder to uncover. The debate over active and passive funds is one example. It has been argued by many that active management does not pay for itself and you are better off investing in a cheap index fund to generate returns for your portfolio. While there are some measures of active share the extent to which an active manager is taking bets is hard to evaluate for the average investor. If a large percentage of portfolio managers are passive in their approach the active managers may be grouped among the majority giving the investing public an inaccurate assessment of active vs. passive. I am not making a case for active or passive I am stating that we don’t have a great measurement for which managers are taking bets. Equally grey is the topic of alternative investing. What defines alternatives, what should define alternative investing and who is it appropriate for?
What are alternative investments? Alternatives investments are defined by Investopedia and Wikipedia as investments in asset classes other than stocks, bonds or cash. They provide examples such as tangible assets including precious metals, art, wine. Other examples are financial assets such as real estate, hedge funds, private equity, venture capital and infrastructure which are more closely aligned to traditional stocks and often invest partially or wholly in stocks and bonds. For example some real estate firms such as Brookfield are listed stocks so which category do they fall into? Infrastructure investments are commonly divided into public and private funds, the former investing in stocks and the later in private deals. Should public infrastructure which are stocks be categorized as traditional and private infrastructure, alternative? Confused? I am.
How should we define alternatives? In my experience alternatives have greater commonality in their investment horizon than their absence of being a stocks, bonds or cash. The perceived investing time frame when buying wine, art, private equity, venture capital or hedge fund is different than purchasing a stock or bonds. The most straight forward difference are the former are generally not available for purchase or sale on a daily basis. Liquidity for “true” alternatives is at best monthly and can be measured in 3-5 year periods for private equity or longer for venture capital. The same asset class can perform differently over the short term and longer term due to liquidity. The daily liquidity of stocks and bonds are impacted to a greater extent by euphoria and despondency. While the value of your home may fluctuate over time it generally does not experience the same volatility as a real estate stock. A greater percentage of the price of your home is based on the utility to the owner of the home and not the short term opportunity of an investor. If we define alternatives more by the investor time frame are alternatives more appropriate for some people versus others.
Are alternatives appropriate for everyone? For the majority of investors my answer is yes. The primary reason I believe this is there is very few situations I have seen in my 25 year career when an investor needed to liquidate their entire portfolio in a day. Most of us cringe slightly when they hear the investment community reminds us, generally in a down market, that we should be “investing for the long term”. Investing for the long term and ensuring 100% of your portfolio can be liquidated in a day seems contradictory. I was in a situation where I needed money and told my advisor to liquidate a couple of investments, one of which was a hedge fund. He reminded me that the hedge fund needed 2 months to settle and I needed the money next week. Since the alternative investments in my portfolio represented 20% of my portfolio I told him to sell the hedge fund and a more liquid investment which I repurchased after the hedge fund settled. Yes, I was out of the market for 2 months but I invest for the long term so I was not to concerned. Despite preaching long term investing the industry makes it more uncomfortable for investors to buy anything that is not daily liquid. If you have purchased an alternative investment you may be familiar with Offering Memorandum or OM documents that make you sign off on the fact that you could loose all your money by investing. That can be said for just about any investment despite the likelihood of that actually happening. If you bought real estate in Vancouver, Toronto, Montreal or any other city in Canada through a limited partnership (LP) you would be required to sign an OM document. If the LP only invested in commercial properties in the downtown core or best residential areas what is the probability that you could loose your entire investment? Not likely, but you would still have to acknowledge the possibility. Investing in an emerging market small cap or technology mutual fund wouldn’t require you to acknowledge the potential to loose all your money but I would put the likelihood ahead of the real estate LP.
With any investment you need to or have a professional do the due diligence to determine whether that investment is relevant for you and your portfolio. Longer term alternative investments may be a better way to grow wealth but need to be balanced with your liquidity needs. Thing are rarely black and white and its equally true that having all your eggs invested in a daily liquid basket is likely not the best solution.