Alternative Investments

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Alternative Investments

Postby colonel » Thu Jun 27, 2013 7:49 pm

Just finished reading Bob Rice's "The Alternative Answer", and he presents some interesting thoughts about the future of the markets. Wondering if anyone else has read it and if so, what opinions you might have?

Specifically, he argues that the traditional stock/bond portfolios do not mitigate risk as they might have in the past. He proposes some alternative strategies that are now available whereas in the past they were only for the very wealthy or institutional investors. Unfortunately, many of these new funds come with a higher expense ratio/costs than index or many traditional mutual funds.

I do think that the investing environment has changed and risk is significantly higher so I am interested in ideas to mitigate some risk. Since many of his suggestions don't flow in synch with the traditional markets they may be an option. Anybody have any thoughts on things like MLP's, Long/Short funds etc. or the books premise?
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Re: Alternative Investments

Postby patrick » Thu Jun 27, 2013 8:01 pm

There's a great deal to be said here, and I'm sure someone else will say more, but here is a start:

In a long/short fund there is the same amount of exposure to stock risk as the net long amount (if any), but you add manager risk. So the only benefit would be if they are really capable of predicting which stocks would do better than others, and were so good at such predictions as to overcome the extra costs.

Is there really more risk now? It may seem like that due to fairly recent market declines, but then again, there have been market declines in the past too. One thing is for sure though -- if you are selling something that you claim will protect from risk, you make more money if you convince people there is a lot of risk they need protection from!
Last edited by patrick on Thu Jun 27, 2013 8:18 pm, edited 1 time in total.
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Re: Alternative Investments

Postby MN Finance » Thu Jun 27, 2013 8:09 pm

Long short funds are possibly the most absurd investment options out there. Its like double manager risk. At least with an active long only fund youll see the fund go up in up markets even if stock picking is bad. In LS, your return is nearly entirely dependent on security mispricing.
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Re: Alternative Investments

Postby Chris M » Thu Jun 27, 2013 10:48 pm

I read Rice's book too. I liked the first 4 chapters, but when he actually got to the meat of the book--discussing the various alternatives themselves--I found it wanting and unpersuasive.

For a very different take on alternatives, try William Bernstein's Skating Where the Puck Was. Bernstein argues that back when David Swensen of the Yale Endowment first pioneered the use of alternatives (hedge funds, private equity, private real estate and commodities futures) in an MPT-based portfolio, he got excellent results. But like most good ideas in investing, once those results became known and the other endowments and pension funds jumped on the alternatives bandwagon, the Yale strategy faltered. Even Swensen himself has suffered poor returns since 2008. Unlike Rice's book, Bernstein provides the hard data to back up his arguments. As just one example, he shows data indicating that as hedge fund assets have soared over the past 15 years, annualized alpha (as measured by the Hedge Fund Research group) has plummetted from +9% to -4.5%. There is, Bernstein theorizes, only so much alpha available to a particular strategy, and once that strategy becomes known the advantage is quickly diluted and dissipated to nothing. Hedge fund investors late to the game are left paying ridicuously high fees for a strategy that no longer works. In addition to hedge funds he discusses commodity futures in some depth. I think he would argue that most other alternatives in Rice's book are in the same boat--if you're reading about them in a book, it's too late.

You can buy Skating Where the Puck Was on Amazon. It's a very short book--really more a pamphlet--but like Bernstein's classics Four Pillars of Investing and The Intelligent Asset Allocator it is thoughtful, insightful and very enlightening.

Cheers,
Chris
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Re: Alternative Investments

Postby nedsaid » Fri Jun 28, 2013 12:26 am

I have been a big believer in diversifying among asset classes. It is a good feeling to know that I was in some of these before they were "cool".

In the late 1980's and into the 1990's, I made money on forest products stocks. I still own two Timber REITs. it was interesting that at a Ray Lucia seminar they were recommending Timber REITs as a good diversifier. Mr. Lucia was over 20 years late to the party. The story is been out a long time, still a great diversifier but you won't get outsized performance here on out.

In the mid 1990's, my favorite mutual fund company offered an Equity REIT fund and I bought. It just seemed like a good idea.

Recently, I was pitched a focused dividend fund that owned 20 stocks or less. I thought cool, I kept my individual stocks and nearly all of them pay good dividends. I declined the pitch, deciding what I had was better.

Brilliance on my part? No. My stockbrokers I worked with were in an office that was a value shop. They got me into value and dividend investing. A lot of the diversification moves I made just made sense at the time. All this stuff had prospects for real return.

The "alternatives" pitched today are mostly complicated vehicles dreamed up by the quants. The one thing that they don't count on invariably blows their models up. No interest in hedge funds, long/short funds, shorting strategies, etc. No interest in asset classes that historically produce zero real returns over time. No commodities or precious metals.
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Re: Alternative Investments

Postby Valuethinker » Fri Jun 28, 2013 6:34 am

colonel wrote:Just finished reading Bob Rice's "The Alternative Answer", and he presents some interesting thoughts about the future of the markets. Wondering if anyone else has read it and if so, what opinions you might have?

Specifically, he argues that the traditional stock/bond portfolios do not mitigate risk as they might have in the past. He proposes some alternative strategies that are now available whereas in the past they were only for the very wealthy or institutional investors. Unfortunately, many of these new funds come with a higher expense ratio/costs than index or many traditional mutual funds.

I do think that the investing environment has changed and risk is significantly higher so I am interested in ideas to mitigate some risk. Since many of his suggestions don't flow in synch with the traditional markets they may be an option. Anybody have any thoughts on things like MLP's, Long/Short funds etc. or the books premise?



Larry Swedroe has a book ('the good, the bad and the ugly'? ) that you should read re alternatives. Also see David Swensen's book on personal investing (he really likes REITs, btw, but I am more cautious-- don't go heavily into a REIT fund without observing the volatility that REITs showed eg in 2008-09 (-10% in a *day*), worth looking at those graphs very hard, and on different scales).

The general message is that given the fees and other issues, it's very hard for the individual investor to 'invest like a pro' in alternatives, and it's not at all clear that professional institutional investors *after fees* do that well from private equity, infrastructure, timber, real estate, hedge funds etc. In fact, risk adjusted, they almost certainly lose money in Hedge Fund investing. Many state pension funds have complete egg on their face through bad alternative investing. Access to the best private equity and venture capital funds is basically invitation only, for example. Ditto the top hedge funds like Renaissance.

Google 'REIT wrecks' and also see Swensen for some entertaining and sad descriptions of the experience of private investors in non traded RE investment vehicles. Huge fees taken out of investors' cash.

If it is being marketed to you as a private investor, it is almost certain to be laden down with fees that will make net performance mediocre. Honourable exception to TIAA RE annuity, which has some attractions (I generally do NOT recommend going over 10% in this fund) if you are eligible (Swensen takes you through that one, there is an active discussion board on Morningstar, but beware the market timing zealousness some show, that's a tricky game to play (although it has worked, you can predict the movement of the TIAA RE fund in the future from past movements in REIT funds).

The listed vehicles for timber don't look good, even though this is an interesting asset class.
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Re: Alternative Investments

Postby meowcat » Fri Jun 28, 2013 7:04 am

colonel wrote:I do think that the investing environment has changed

In my own opinion, I don't believe this to be the case. The "environment" is, and always will be, the fact that no one knows what the markets will do going forward. The very foundation of investing has remained the same for over 400 years. It sounds cliché and has been repeated over and over again on this board and others, but the words "stay the course" are truly the most valuable words of advice and has always served the core principles of any IPS.
More people should learn to tell their dollars where to go instead of asking them where they went. | -Roger Babson
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Re: Alternative Investments

Postby colonel » Fri Jun 28, 2013 9:13 am

Thanks to all for the comments.

meowcat wrote:
colonel wrote:I do think that the investing environment has changed

In my own opinion, I don't believe this to be the case. The "environment" is, and always will be, the fact that no one knows what the markets will do going forward. The very foundation of investing has remained the same for over 400 years. It sounds cliché and has been repeated over and over again on this board and others, but the words "stay the course" are truly the most valuable words of advice and has always served the core principles of any IPS.


I guess in response to meowcat, my reasons for the "environment change" comment are that I think in the past there used to be more diversification options that don't seem to exist today. Specifically, investing in foreign and US stocks created some diversification which I think has changed. In my opinion markets today move more in synch than what they did in the past. Take for example the recent Fed discussion of Quantitative Easing and the churn that created in US markets but also how that effected not only US but also Brazil and China. I guess my point is that I think technology now has created a more "one-world" investing environment and although good in some aspects makes it is a lot harder to find diversification. That is why I was interested in thoughts on alternatives.

Any comments on what makes up that "prime" diversified portfolio? I think Im am pretty diversified at about 60/40 with stocks/bonds. Large cap 25%, international 15%, small 15%, & 5% gld/REIT) Bonds divided with TIPS 5%, Intermed 30%, Foreign 5%) but I am always open to reading others ideas.
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Too much diversification ?

Postby Taylor Larimore » Fri Jun 28, 2013 9:34 am

Colonel:

We must be careful of too much diversification.
"Diversification is the last refuge of the scoundrel." -- Jack Bogle

Investopedia explains:

Top four signs of over-diversification

Best wishes.
Taylor
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Re: Alternative Investments

Postby nisiprius » Fri Jun 28, 2013 9:54 am

By "long-short funds," do you mean like the 130/30 funds that were all the rage circa, I dunno, 2007-2008 or so? I haven't heard much about them lately, have you? I betcha a nickel it's because they haven't been doing so well, but I haven't checked and I'm too lazy to check.

Some obvious points. First of all, "Bob Rice is Bloomberg TV's Alternative Investments Editor," what do you expect him to say? Second, I have great respect for The Only Guide to Alternative Investments You Will Ever Need: The Good, The Flawed, the Bad, and the Ugly, by Swedroe and Kizer, and you should probably read it, too. Third, all the stuff about "alternative investments" is driven in part novelty and the need for something to write about and the urge to launch and sell new products. And recency. Whenever stocks and bonds aren't doing so well, it creates an opportunity so sell any old weird stuff with the sales pitch that "it isn't stocks or bonds."

Very slightly less obvious: the blurb on Amazon says "The Yale Endowment keeps only 6% of its investments in US stocks, but its portfolio has produced a 100% gain over the past decade. Indeed, the world’s elite investors have long relied on alternative investments to produce their superior returns. Until now those options were the exclusive purview of institutions and the super wealthy, but today any informed investor can play the same game." There is so much wrong with this, so much obvious "spin," that it would lead me not to even read past the blurb. Rick Ferri wrote a caustic pieces about The Cure of the Yale Model.

As for "ideas to mitigate some risk," I think that's barking up the wrong tree (and leaving yourself open for snake oil). I believe that you don't get the risk premium unless you are willing to take the risk, and that one should simply accept the risks, e.g. of stocks. One of the reasons I'm a relative fraidycat is that I think that I actually do accept those risks--and that many "less risk-averse" investors are not really less risk-averse at all, they have simply kidded themselves into believing there's less risk. Be a big boy, take the risk. Accept that fact that sometimes there are just lousy periods for stocks, and sometimes lousy periods for bonds, and sometimes lousy periods for both. There's no reason why there has to be an "answer." Nobody ever promised investors were entitled to win all the time.

The great virtues of the traditional investments--securities--is that while I don't profess to understand short-term market movements, there is a very direct, simple explanation of why I should expect them to make money at all. Both stocks and bonds derive their returns from the actual business operations of endeavors that in at least some cases honestly creates actual value (yes, I include government in that). Even if you feel that the value-creation story for stocks is a mostly a fig leaf intended to give respectability to what is at heart speculation, it's still seems valid. All of the "alternative" investments are somewhat weird. I can't quite convince myself that I deserve to earn a return simply for sitting on top of a bar of gold, for example.

The other virtue of the traditional investments is that however imperfect it is, there are at least long-term records that are pretty easy to dig up. That makes it pretty easy to assess the risk. And, in the case of both stocks and bonds, the long-term risk/reward study is good, and not unreasonably long-term. Stocks, if you look at the total market, have a fair amount of risk and a fair amount reward and your chances of catching some of that reward over three or four decades look pretty good. Bonds have less risk, less reward, and to me it looks like your chances of catching that reward over any single decade look pretty good. A lot of the alternatives seem to have low reward, so it is all a correlation story--or, if they have a reward, they have peaks and valleys that take a century to average out. Real estate, represented by the almost four centuries of data for Herengracht, crashed and stayed down for well over a century.
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Re: Alternative Investments

Postby nisiprius » Fri Jun 28, 2013 10:13 am

Darn. "Made me look."

Proshares 130/30 Fund: Giant Leap for ETFs? By golly, the date is in fact 2007.
In a major new development for the exchange-traded fund [ETF] industry, ProShares has filed papers with the Securities and Exchange Commission [SEC] for a new "130/30" ETF.

The new fund will use a proprietary, quantitative analytical system to rank all of the large-cap stocks in the U.S. market. It will then take a 130% long position in the high-ranked stocks and a 30% short position in the low-ranked stocks. The goal is to capture additional alpha and generate excess returns while retaining a net 100% exposure to the market.

This kind of "130/30" strategy is one of the fastest-growing segments of the financial industry. According to Morgan Stanley, there is now more than $100 billion invested in 130/30 funds worldwide. Most of that money is run by hedge funds and other high-cost products targeted at institutions and ultra-high-net-worth investors, and nearly all of it by active managers. The new ProShares fund, in contrast, will make the strategy available to all investors at a relatively low cost using an index-based approach.
Hmmm... that ProShares fund seems to have been CSM and it's changed its name to ProShares Large-Cap Core Plus. Fidelity had one, the Fidelity 130/30 Large Cap Fund (FOTTX), and... it seems to be...

...gone.

Yep, FOTTX death certificate.

A Financial Times article The decline, fall and afterlife of 130/30
Back in the heady days of 2007, Merrill Lynch confidently predicted that newly fashionable 130/30 funds – a breed of long/short equity funds – would reach $1tn in assets by 2012. Not to be outdone, Tabb Group, a consultancy, raised the stakes to $2tn by 2010.
Sadly for both punters and the purveyors of all things 130/30, the number-crunchers at Lipper could only identify 31 such funds with combined assets of $9bn across Europe and the US at the end of 2012, below the twin peaks of $9.4bn (2010) and 66 funds (2008).
And what that means, if there were 66 funds in 2008 and only 31 left, and since, alas, Morningstar only lets me plot funds that exist, I can't really do much valid exploring because of survivorship bias--the only ones I'm going to be able to find are the ones that did better. For the record, I did peak at CSM and it is virtually coincident with the growth chart for Total Stock Market. (They must have done the near-equivalent of going long on the total market AND shorting the total market...)

So, are "long/short" funds fairly represented by 130/30 funds, or does "long/short" funds mean something different? Anyone know?
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Re: Alternative Investments

Postby Valuethinker » Fri Jun 28, 2013 10:30 am

colonel wrote:Thanks to all for the comments.

meowcat wrote:
colonel wrote:I do think that the investing environment has changed

In my own opinion, I don't believe this to be the case. The "environment" is, and always will be, the fact that no one knows what the markets will do going forward. The very foundation of investing has remained the same for over 400 years. It sounds cliché and has been repeated over and over again on this board and others, but the words "stay the course" are truly the most valuable words of advice and has always served the core principles of any IPS.


I guess in response to meowcat, my reasons for the "environment change" comment are that I think in the past there used to be more diversification options that don't seem to exist today. Specifically, investing in foreign and US stocks created some diversification which I think has changed. In my opinion markets today move more in synch than what they did in the past. Take for example the recent Fed discussion of Quantitative Easing and the churn that created in US markets but also how that effected not only US but also Brazil and China. I guess my point is that I think technology now has created a more "one-world" investing environment and although good in some aspects makes it is a lot harder to find diversification. That is why I was interested in thoughts on alternatives.

Any comments on what makes up that "prime" diversified portfolio? I think Im am pretty diversified at about 60/40 with stocks/bonds. Large cap 25%, international 15%, small 15%, & 5% gld/REIT) Bonds divided with TIPS 5%, Intermed 30%, Foreign 5%) but I am always open to reading others ideas.


Real diversification would be hard. Directly owned real estate. A career which was somewhat insensitive to market movements (or even contra cyclical). Ownership in equity in a personal business that similarly was not directly linked to asset markets.
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Re: Alternative Investments

Postby Valuethinker » Fri Jun 28, 2013 10:31 am

nisiprius wrote:So, are "long/short" funds fairly represented by 130/30 funds, or does "long/short" funds mean something different? Anyone know?


130/30 were a retail version. Of a much bigger asset class of hedge funds (that take long and short bets)-- usually only available to high net worths and to institutional investors.
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Re: Alternative Investments

Postby Chris M » Fri Jun 28, 2013 3:17 pm

colonel wrote:Any comments on what makes up that "prime" diversified portfolio? I think Im am pretty diversified at about 60/40 with stocks/bonds. Large cap 25%, international 15%, small 15%, & 5% gld/REIT) Bonds divided with TIPS 5%, Intermed 30%, Foreign 5%) but I am always open to reading others ideas.


Colonel,

I'm assuming your reference to gld above is to physical gold or one of the gold ETFs. Have you thought about precious metals equities? PME correlations with stocks are still low (in fact they've declined since the early eighties). PME average mutual fund returns went way up (about 50%) in both the 1973-74 and 2000-02 bear markets. Although they declined in both 1987 and 2007-09, the declines were nowhere near as large as the S&P 500 (less than half the S&P's decline in 2007-09). They can be thought of as an investment in gold in the ground, as they tend to react to movements in the gold price--but with the significant advantage that they actually produce earnings and dividends. They are very volatile, but I view high volatility as a desireable characteristic in an asset class that has low correlation with other stocks and is intended as a diversifier. PME prices have dropped precipitously over the past 3 years, so you can now buy in well below their former top.
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Re: Alternative Investments

Postby LadyGeek » Fri Jun 28, 2013 7:33 pm

This thread is now in the Investing - Theory, News & General forum (general investing, theory).
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