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A Few Notes on The Alternative Answer

| | Posted in: Individual Investing, Strategic Allocation

In the introduction to his 2013 book entitled The Alternative Answer: The Nontraditional Investments That Drive the World’s Best-Performing Portfolios, author Bob Rice (Alternative Investment Editor at Bloomberg Television) states that his: “…basic approach is an adaptation of the strategic asset allocation model that endowments have used for years, one that reflects two critical modifications. First, there is great focus on liquidity and inflation-protected income. Second, it incorporates the latest analysis regarding portfolio construction, specifically regarding accumulation of risk premiums and avoidance of cross-asset vulnerabilities. …Modern investors need modern tools. And they exist; it’s just that there’s been no reliable user’s guide. Now, I hope, there is.” Based on the practices of selected “elite” investors, he concludes that:

From Chapter 1, “The Alternative Manifesto” (Page 7): “…the big news is not so much that alternative investments can provide much smarter and safer ways to generate income, grow portfolios, protect wealth, and transfer it… Rather the headline is that these strategies are now accessible to nearly everyone…”

From Chapter 2, “Do Alternatives Work?” (Page 28): “The biggest key to long-term wealth creation is loss avoidance. That requires a ‘risk-tolerant’ portfolio that combines active risk management for liquid securities (hedged styles); a thorough mix of noncorrelated return streams; and investments that aren’t all susceptible to a single type of economic risk. Manager selection matters much more with alternatives than with stocks and bonds. Whereas the best stock pickers outperform the worst by 2x, the best alternative managers outperform the worst by 10x or more.”

From Chapter 4, “Major Alternative Structures” (Page 73): “Liquid alternatives change the investing landscape in much the same way as the advent of mutual funds did. ‘Smart beta’ and alternative strategies can be accessed through these low-fee, fully transparent, registered and regulated vehicles. …Liquid alternatives really are great, but they are not always better. Old-school private placements are still where you’ll find most of the best overall returns.”

From Chapter 5, “Higher, Inflation-Protected Current Income (Job 1)” (Page 98): “MLP investments and various kinds of royalty streams are terrific sources of noncorrelated income, and also offer rising income to help offset the risks of inflation. Be careful exactly how you buy, as the net after-tax yields from different vehicles can vary dramatically. In the search for yield, emerging market debt is one of the better choices… But invest behind a good manager. Multiclass ETFs are a strong new yield choice for average investors, combining income flows from various other sources…”

From Chapter 6, “Broadening the Base for Risk Reduction (Job 2)” (Page 127): “The single biggest thing average investors can do to improve their portfolios is to add protection against adverse stock market moves. The numerous new smart beta products, especially mutual funds of funds that aggregate various long/short managers, deserve a close look by almost everyone.”

From Chapter 7, “Long-Term Growth Enhancement (Job 3)” (Page 129): “Although there are liquid alternatives that address some of these strategies, the majority come in private placement form, and so require committing dollars for at least some period of time (from one year to several). That’s because these styles just take a while to reach fruition, and because the best managers require locked-up money to go to work.”

From Chapter 8, “Purchase Power Protection (Job 4)” (Page 182): “For average investors, TIPS (bought properly, as described) are as close to a no-lose bet as you’ll find on this earth. And for the wealthier, direct timber ownership is close behind.”

From Chapter 9, “The Big Picture” (Pages 188, 204): “…for those deeply immersed in the 60/40 world, how do we get from here to there? The top priority for most investors is getting away from the extreme interest risk of traditional bond funds. I’d suggest moving out of those and into the liquid alternative income investments…, along with TREITs [timber] and TIPS. …On the equity side, the suggestion is to first limit volatility by rotating long-only holdings of traditional mutual funds and ETFs into long/short, multi-alternative, and managed futures mutual funds. …Illiquidity premiums are high these days, and investors who can afford to grab them probably should.”

From Chapter 10, “At the Dealership” (Page 225): “Doing the work to decide whether to invest in a private transaction can seem a bit overwhelming, but an awful lot of it is just common sense: Is the management team of unquestioned integrity? Do the professional advisors have the right pedigrees? Do the principals’ economic incentives align with those of the investors? What’s the track record look like?”

From “Conclusion: It’s Time!” (Page 227): “The periodic crashes that have bedeviled 60/40 portfolios in the past are nearly certain to repeat. Alternative investing strategies do in fact give nearly every investor the ability to improve his chances of surviving the next one(s) in decent shape…”

In summary, readers unfamiliar with the alternative investments landscape may find The Alternative Answer a useful survey of choices.

Cautions regarding conclusions include:

  • As noted in the book, some of the best alternative investment opportunities are likely inaccessible to many individual investors. It is not obvious that versions of these opportunities recently packaged in mutual funds and ETFs for “retail” consumption perform well.
  • The author generally does not quantify, or cite formal research in support of, arguments and conclusions beyond anecdotes about “elite investors.” For example, he does not quantify reasonable expectations for the performance metrics of a well-constructed portfolio based on the book’s advice.
  • Portfolio construction discussions in the book do not integrate direct real estate ownership via a home or homes.
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