Wonderful, wonderful news.
At least if you’re a creative money manager with a good line in blarney.
Nine out of 10 financial advisers say they plan to pour clients’ money into “alternative” investments over the next couple of years, including such lucrative high-fee vehicles as private equity, private credit, hedge funds, venture capital and the like.
Whether this will be such good news for the clients is another matter. But they, famously, are rarely the ones with yachts.
“As they face uncertain markets, nearly nine in 10 financial advisers (88%) surveyed plan to increase their allocation to alternatives over the next two years,” reports a new survey published by CAIS, which calls itself “the leading alternative investment marketplace for independent financial advisers,” and Mercer, an asset-management company. It adds that, “Of those, more than half (53%) estimate that their allocation to alternatives will make up more than 15% of their overall client portfolios. Meanwhile, more than 20% said they would allocate more than a quarter of their portfolio to alternatives.”
A mere 8% said that they do not plan to increase these allocations at all during the next couple of years.
Granted, this may not be a fully representative sample of the entire money management industry. CAIS and Mercer polled 200 financial advisers who had turned up to their Alternative Investment Summit last month at the Beverly Hilton Hotel in LA. Those attending were, naturally, more predisposed toward “alternatives.”
But there’s no reason to think this finding is directionally wrong. Institutional investors have been lured by the siren song of alternatives for several years. And the latest poll coincides with a moment of extreme revulsion—some might say, “capitulation”—toward the traditional assets of stocks and bonds because this year they have absolutely sucked.
So far this year, the S&P 500
stock index has lost 15% and the S&P U.S. Aggregate 13%. The bond market has had one of the worst, and possibly the absolute worst, performance on record. No wonder the latest BofA Securities survey of institutional investment managers worldwide show they are shunning both stocks and bonds, while holding more than usual levels of cash, alternatives and commodities.
There are multiple problems with most alternatives. There is the fallacy of composition: If private-equity managers and hedge-fund managers plan to outperform by “beating the market,” there is only so much money they can take in. Otherwise you end up in the situation where everyone is expecting to beat the market.
Then there is the Heraclitus problem, meaning that the future will not be the same as the past. Private-equity managers benefited enormously from the long-term collapse in interest rates from 1982 until, well, last year. They were able to buy companies with cheap debt and then flip them. What happens if rates continue to go back up? We shall see.
Then there are the liquidity and transparency problems. You know what your publicly traded stocks are doing, because you can see the prices in real time. Not so private funds, many of whom furthermore make their money on untraded assets. How do you properly “value” an untraded asset, like a small company in the middle of an uncertain, multiyear turnaround? You can’t, really.
But above all there is the “agency” problem. The people running these ventures generally make out very well, but that doesn’t always translate into big bucks for the investors, because of the fees.
It is mathematically implausible for hedge funds to beat the market over time. And business school professor Ludovic Phalippou at Oxford University calculates that overall private equity returns have been no better than the stock market since at least 2006.
Important note: That is especially astonishing because during that period, from 2006 to 2020, the interest rate on BBB-rated corporate bonds halved. So the private equity crowd, who make their money by purchasing undervalued companies with debt, should have been making out like bandits.
Some people argue that things like real-estate investment trusts (REITs), infrastructure investments and master limited partnerships (MLPs) count as “alternatives.” But they have suffered this year along with stocks and bonds.
The one standout so far in 2022 has been commodities. The S&P GSCI Commodity Index is up 30% so far this year.
A fascinating research paper by the number crunchers at AQR, a hedge fund firm in Greenwich, Conn., suggests that if anyone feels they need to add something else to their portfolio of stocks and bonds, they might not need look any further than commodities. The paper, using commodities data going back to the 1870s, finds that commodity futures have added value to a traditional portfolio over time, zigging when everything else zagged (like this year) while generating a positive overall return.
“We find that, over the entire sample, the optimal mean-variance portfolio allocates 17% to commodities, 29% to stocks and 54% to government bonds,” write the authors, Ari Levine and Yao Hua Ooi of AQR and professor Matthew Richardson of NYU’s Stern School of Business. “Moreover, a 54%/36%/10% portfolio of stocks, bonds and commodities consistently outperforms a 60%/40% allocation of just stocks and bonds.”
Doug Ramsey’s “All Asset No Authority” portfolio at Leuthold, arguably the ultimate all weather portfolio, includes the commodity index and gold as two of its seven components.
Those who want to own commodities can do so without dealing with high-fee investment managers. There are a variety of ETFs that invest in commodity futures, including the iShares S&P GSCI Commodity-Indexed Trust
among many others. (Thanks to the tricky nature of commodity futures, many perform slightly differently from each other. You need to check the data before buying.) Their fees aren’t low—GSG charges 0.75%, which is expensive compared with stock and bond ETFs, but a bargain compared with any private-equity fund or hedge fund.)
Naturally the best time to buy commodities was last year—or actually during the COVID-19 crash in 2020, but that’s another story—and not now, once they have already risen a long way. If we are heading into a recession the next move may be down. And when commodities go down, they can really, really go down. (The S&P GSCI Index fell two-thirds during the global financial crisis.)
It is dismally predictable that the global money managers who say they are shunning stocks and bonds are heavily into commodities.
But commodities can at least genuinely claim to be a third asset class, alongside stocks and bonds. And timing aside, there are worse ideas than, in general, including some alongside the others. It helped this year and it may help again in the future.
But hedge funds? Private equity? We shall see.