By now, you’ve likely heard the term FOMO – the Fear of Missing Out. You’ve likely also heard the term TINA –– There Is No Alternative. Taken together, these handy little pop culture acronyms explain a good deal of what has gone on in capital markets over the past two years or so. I’d like to take this opportunity to push back a little on the second one. Based on current valuations, there may not be a sensible alternative to stocks, bonds, and real estate, but there may well be an alternative in…. wait for it…. alternatives.
Alternative assets are varied and the term ‘alternative’ could mean different things to different people. The asset class is known to on a non-correlated basis by offering opportunities in such varied assets as infrastructure, liquid alternatives, structured notes, and hedge funds. While I personally dislike the last option due to high fees, illiquidity, and opaque reporting, I believe there’s often a strong case that can be made for adding alternatives to your portfolio immediately. As such, here’s a new term: TIARA. It stands for: There Is A Real Alternative. You’re not stuck with having to only choose between some combination of stocks and bonds.
In the past half decade or so, many more traditional asset allocation strategies have changed significantly as bond yields have declined. The asset class that has been gaining the most traction is alternatives. According to the Pension Investment Association of Canada, the average allocation is now split into thirds, allocating to Equities, Fixed Income and Alternatives. While I think that’s suitable for pension funds, regulators have taken the position that investors ought to have a more measured position. Most commentators think a 10% allocation would be beneficial and many are prepared to recommend an allocation of 20% or higher.
ETFs and mutual funds can capture the intended risk premia investors seek in alternative investments, providing a more robust data set to model risks and enhancing liquidity. Examples include infrastructure and liquid alternatives. As such, the democratization of investment vehicles continues unabated, and ordinary investors are gaining access to products and strategies that were within the exclusive purview of multi-billion-dollar entities just a few short years ago.
Since there are so many products available, it would be difficult to offer a more specific summary. Alternatives involve multiple strategies and multiple risk appetites. The one thing that seems to be consistent, however, is that alternative products and strategies are generally non-correlated to traditional financial assets (stocks and bonds). The impact will depend on performance, but at a minimum, exposure to a well-designed alternative product or two should lower overall portfolio volatility. That’s likely going to be important, because people have grown complacent with the strong and relatively stable returns they’ve grown accustomed to as a result of a prolonged stretch of accommodative monetary policy. Remember this when you’re topping up your RRSP in the coming weeks: There Is A Real Alternative.