In part two of a four-part series, Dr. Brian Jacobsen discusses the when and the where of alternative strategies.
This month, we’re looking at how to put alternative investments to work. When do these different strategies work, and when do they not? And also, importantly, where do they fit in a portfolio?
Not every strategy works in every environment.
With the equity hedged and relative value strategies, those tend to work a little bit better in fairly directionless, but choppy markets. Global macro strategies – those tend to work when you have a lot of policy changes taking place not only domestically, but even globally. Thinking about the environment in which we’ve gone through over the last year, where you have the Federal Reserve talking about raising rates and yet the European Central Bank is now engaging in an asset purchase program, that’s creating some volatility and valuation differentials in those various markets. That’s where perhaps a global macro strategy could perform well.
Then you also have the event driven strategies. Those tend to be a little bit more individualized and specific to companies as far as what they’re doing on the merger and acquisition front, whether or not they are announcing new dividends or share buybacks, or if there’s any new drug, perhaps, that they have created that is going to receive FDA approval. Those are all types of events that can make an event driven strategy work. Those clearly are relatively unpredictable and create opportunities for managers who do a lot of due diligence on the companies that they invest in to really add some value.
Now, hopefully, what you’ve seen with these different strategies is not all of them work at the same time, which is why I think that it makes a lot of sense to take these four and combine them into a portfolio of alternative strategies. That can hopefully make more consistent returns and also allow an expert manager to manage the risk of that overall portfolio.
So let’s talk about where alternatives fit in a portfolio. Perhaps the number one question to ask is: How do you feel about your current allocation? Are there parts of it that keep you up at night? Because investing isn’t something that should keep you up at night. If it’s the equity portion of your portfolio, well, perhaps you want to swap out a small part of the equity exposure in favor of alternatives. Or if it’s the fixed-income portion, because you’re concerned that interest rates might bounce higher, that might be a good place to substitute in alternatives for your existing lower-yielding fixed-income exposure.
But wherever it is, I think that you can think of alternatives as being either at the core of your portfolio and you build around that or alternatively you can stick to your strategic allocation of traditional assets and then add on alternatives around what we would refer to as the satellite portion, looking for more of the opportunities to generate returns in a more consistent fashion over a full market cycle.
But wherever it is that you think alternatives should go in your portfolio, take advantage of the commentary (pdf) that you can receive from the alternatives managers. Keep in mind alternative strategies are typically global in nature and give you access to new ideas. It’s actually a great way to not just diversify your assets, but to diversify the ideas that go into your asset allocation, because that’s what alternative investing is really all about.
I’m Brian Jacobsen, until next time, stay informed.