More Than Stocks: Don’t Neglect These “alternatives” When Thinking About Your Portfolio

In his book “Pioneering Portfolio Management”, Swensen describes the process that is making the Yale endowment the most successful strategy in investing. Most investors think in terms of equities, but we’ve known since the 50’s that the more types of risks and asset classes included in a percentage based portfolio, the more resilient and potent the returns are from re-balancing and hedging. With the shiller-PE near 34, it’s more important than ever to remember that “diversification” isn’t just for what (US) companies to own.

Many investors make the mistake of valuing their portfolio in their home currency without accounting for currency risk. They may own US equities, while valuing their portfolio in Euros, and will have seen dramatic declines during the latest bull run. In the past, paying 3-6 basis points (a point is .01{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163}) for a currency forward was the purview of high-net-worth individuals (HNWI), but today the FX family of funds provides coverage even for retail investors, with FXE (the euro), FXB (for the pound), FXY (yen), and FXF (swiss franc).

In bond markets, most retail investors fail to recognize the difference in risks between the interest rate or credit risks, and may be inappropriately paying a fund .4{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163} – .6{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163} in fees for a bond index providing only shorter term or AAA rated corporate risks. Fidelity offers a low-cost long-government fund with similar exposure to interest rate risks as the TLT fund available on the NYSE Archipelagos (NYSEARCA). The newest form of bond risk available, comes in the form of the so-called “cat-bond” which provides access to insurance risk, in which default is caused by a large insurance payout from a catastrophe.

The theme here is to have types of risks and assets that move independently, and the first of these to be included in the “Efficient frontier” calculations with stocks and bonds was oil, which is today possibly better thought of under the broader heading of “energy.” Finding the right exposure to energy for the retail investor can be difficult, the futures traded for WTI are no longer available in NYSEARCA ETF’s, instead products such as GUSH or DRIP provide speculative leverage. Because of the decay and the high fees (more than 1{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163}) for funds in the global commodities markets, this continues to be a difficult asset class. Many portfolio managers are turning to private-equity deals for the more attractive looking “multiple” for their larger portfolios, especially given that energy has become a staple in the S&P 500.

REIT’s represent the best buying opportunity in the last year, over the past few weeks real estate valuations and indexes have dropped as much as 5{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163}, while the SPY has risen almost as much. Those who wait a year between re-balancing could find that this was a missed opportunity.

Catching everyone’s attention is cryptocurrency, as more are seeing it as an alternative asset class, especially Litecoin, Etherium and Bitcoin. The sober-minded manager will no doubt want to include this new risk, but would be well advised to keep a flat amount and rebalance periods of high volume and volatility to maximize these shifts, which are liquid 24/7. Large positions for HNWI or UHNWI clients should be kept in so-called “cold wallets”, a printed out key kept in a safety deposit box at a bank.

For the smaller investor, PUTW presents an attractive “alternative” fund similar to hedge funds who produce their return by writing (selling) naked puts. In the past, only HNWI managers searching Fundbase could find these, and opening a series required perhaps millions of USD. A put is a type of option which allow the buyer to bet on lower prices. In the long-running bull market, periods where prices neither increase or decrease may last as long as increases in prices, producing lackluster returns for the SPY or QQQ, while PUTW continues a steady climb.

Puts are a valuable way to hedge against so called “black swan” events. Currently several technology stocks provide an opportunity to buy puts for companies losing money at unheard-of rates. A small position in such puts comprising less than 1{aa0b3fd8d4f6229cc96a3f816a51d9ae4c8df2019ccaebcb59304067d0e09163} of your large-cap position as a generic hedge is important to remember as a form of market insurance that also allows for the greatest likelihood of companies that might fail in any market.