For a lot of financial advisers, a 5% or 10% allocation to alternative investments is still viewed either as pushing the limits or as checking off the box for having some exposure to alternatives.
But what about a 45% allocation that represents the core of a client's investment portfolio?
That, essentially, is the model employed by a lot of multibillion-dollar endowments and foundations, and it's the model being rolled out for individual investors by Dick Pfister, chief executive and president of AlphaCore Capital.
It is a strategy that is sure to attract plenty of critics and naysayers, particularly among advisers who believe the stock market can grow to the sky and bonds can still be measured by past performance.
But
at this point in the market cycle, with stocks riding the second-longest bull market since World War II and bond yields pegged to an unprecedented Fed-imposed floor, alternatives are starting to look like the more conservative play.
“I think advisers should be embracing a lot of alternative exposure, because in this environment, a large allocation to alternatives is fundamentally correct,” said Bob Rice, managing director at Tangent Capital.
“It's not always right to have half your portfolio in alternatives, but it is right now,” he added.
Mr. Pfister, one of the founders of Altegris mutual funds, came to this realization within his own portfolio model a few years ago after his
fund complex was acquired and he was left with a pile of money he needed to invest.
What he found was that a lot of financial advisers and wirehouse representatives were pushing the same stale portfolio of 60% stocks and 40% bonds.
KNOWLEDGE VOID
“You might find a guy who would put 10%, or maybe 15%, in alternatives and that would be considered really aggressive,” he said. “I realized there is a huge void in the knowledge level among financial advisers with regard to alternatives.”
Like a lot of
true believers in the alternatives camp, Mr. Pfister's strategy is based less on outperformance objectives and more on risk management.
What a lot of advisers don't seem to recognize is the risk of just sitting in what are often perceived as the least-risky assets. In other words, long-only stocks and bonds.
Mr. Pfister lays out a scenario of a 55-year-old in 1999 with $1 million invested in the Russell 3000, and hoping to retire this year.
Assuming he was able stay invested through the peak of 2000, through the 32% decline to the trough of 2003, then another ride up to right before the 2008 financial crisis and another gut-wrenching correction, he is now 70 and holding a $2.49 million portfolio.
The annualized return of 5.8% is only a hair better than the 5.7% annualized return of a portfolio invested in 60% stocks and 40% bonds over the same period. The difference would have been a slightly less volatile ride, which might have been enough to keep the investor from running to the sidelines.
Take that same wild ride on the AlphaCore model, which, admittedly, is back-tested, and the annualized return is 7.6%, pushing the total portfolio to $3.3 million over the same period.
The key difference can be found in the first market pullback after the tech bubble burst in 2000.
At the end of 2002, the AlphaCore portfolio was at $1.2 million, while both the all-stock and the 60/40 portfolios had shrunk to $780,000.
“That's the real key to including alternatives,” Mr. Pfister said. “You lower risk and make more by losing less.”
From that base at the end of 2002, the AlphaCore portfolio would have grown to $2.4 million by the end of 2007, while the all-stock portfolio reached $1.4 million, and the 60/40 portfolio reached $1.6 million.
The big drop from the financial crisis, which bottomed in March 2009, pushed the AlphaCore portfolio down to $1.8 million, but the all-stock portfolio slumped to $757,000, and the 60/40 portfolio hit $1.1 million.
Mr. Pfister, who primarily is using registered liquid alt mutual funds for his core allocation, did the back-testing using hedge fund indexes.
CORE IS STATIC
The core of the portfolio, which is designed to be a static allocation, includes managed futures, global macro, event driven, multistrategy and relative value funds.
The rest of the portfolio is high-yield and global core bonds, emerging-markets stocks, real estate and commodities, as well as both public and private long/short equity.
Note that some of what Mr. Pfister calls traditional — including commodities, real estate and long/short equity — are often considered alternative strategies. With that in mind, it could be argued that the portfolio is actually closer to 60% allocated to alternative investments.
That will clearly not sit well with a lot of financial advisers, but it will be interesting to see what tune they're singing after the market corrects.
Thomas Meyer, chief executive of Meyer Capital Group, and a proponent of using alternative strategies, said he tops out at a 25% allocation to nontraditional assets.
“If [Mr. Pfister] would have had that [AlphaCore] allocation over the past six years, he would have severely underperformed,” Mr. Meyer said.
That's probably true, but as Mr. Pfister pointed out, the focus on alternatives right now is more about defense than offense.
