by Thomas Meyer
As we begin the second half of 2014, it would be wise to heed the words of Ben Graham – the mentor to Warren Buffett. “The essence of portfolio management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.” A prudent formula to adhere to this philosophy would be to incorporate “liquid alternative strategy” mutual funds into your asset allocation mix of stocks, bonds or ETF’s. According to DailyAlts.com, liquid alternative mutual fund assets jumped 43% in 2013. With billions of dollars flowing into the space and hundreds of new products coming to market, there’s definitely something for everyone; however, you need to do your due-diligence on the particular strategies, fund and management team and the firm. You also need to figure out how they will fit into your portfolio before you invest.
This philosophy should help to lower the volatility of your portfolio, especially in a market that has been highly correlated in the past few years and bouncing around record highs. While we all know that the only guarantee in the stock market is risk, why don’t most individual investors have strategies that can curb that risk or that will take advantage of this fact?
The answer lies in one of our favorite sayings. It’s because we are all human and that “fear is temporary while greed is permanent”! However, most individual investors don’t seem to want to think about words like risk and volatility as long as the markets keep going higher. So in this environment are you willing to lose less or take on more and more risk to try to make more?
When you consider the demographics of investors, with the sweet spot being between the ages of 55-65, our experience is that many of these investors are still scared and exhausted by the stock market events during their investment careers. Even after great returns in 2013, most would prefer not to assume “market risk”, but while interest rates are still low there wouldn’t seem like anywhere else to “play” except for the stock market. Speaking of market risk, do you know your portfolio risk statistics (beta, standard deviation) compared to the market? If not, we recommend you speak with your financial advisor sooner rather than later to request that they provide and explain this data to you.
Our point is that in this environment if we must “play” why not curb the market risk and cocoon your long-only, style box constrained investments with liquid alternative strategies. This could include tactical managers that can go to 100% cash/bonds in crisis, long/short, market neutral, and merger arbitrage just to name a few. There are also plenty of names to help with your fixed income portfolio risk as well. The beauty of employing such diversification is that it can be done by utilizing no load open-ended mutual funds, which provide liquidity, transparency and daily pricing. We can now avoid the hedge funds high average 2% management fee and 20% of profit cost, $1- $20 million dollar minimums and illiquid investments.
Finally, this is not just another investment fad. This is the opportunity for individual investors to build an institutional style portfolio without having millions and millions invested. High net worth investors, large endowments, and corporate retirement plans have been enjoying the benefits of these strategies for decades. We also want to be quite clear that there is no silver bullet when investing. Everything in life involves risk and you can lose money when investing. The objective is to know the risk and try to reduce it. You cannot eliminate it completely. If someone tells you that you will never lose money using alternative investment strategies, run the other way!!
To learn more about Thomas Meyer, view his Paladin Registry profile.