I admit it. I went to the panel with an already skeptical attitude.
The presentation, held at Morningstar’s Investment Conference, was titled, “Liquid Alts: The Square Peg for Your Round Portfolio,” and it promised that, “when used responsibly, liquid alternatives give investors the potential to improve their portfolios’ risk-adjusted returns over the long term.”
I was dubious. For quite a while, I’ve believed that alternatives are far better for the providers than for clients. But I did my best to listen to the expert panelists with an open mind. Could they change it?
Morningstar analyst Jason Kephart, who moderated, defined alts as investments that aren't market dependent, but after that, opinions diverged widely on what is truly considered an alternative investment, and which were the best options for investors and advisers.
For Robert Boyda, John Hancock's head of capital markets and strategy, alts are mechanisms to make money that are based on skills and offer absolute return — like long-short funds and foreign currency investments.
Yet Catherine LeGraw, a member of GMO's asset allocation team, is pessimistic on stocks and bonds and says long-short, relative value, and the like have better expected returns.
Joel Dickson, Vanguard's global head of investment research and development, says alternatives can be illiquid private equity and public securities comprised of these private investments.
MORE ATTRACTIVELY PRICED?
It was pointed out that Vanguard's Managed Payout fund had alternative funds embedded in it, including a market neutral fund. The panelists stressed that alts have low and negative correlations to stocks and bonds, though LeGraw noted they could give negative returns during a stock downturn. Her belief was that alternatives were more attractively priced than stocks and bonds.
Vanguard’s Dickson finally mentioned that, while diversification is good, there is a tradeoff on costs. Alternatives belong in target date funds according to Boyda, claiming they have "reasonable fees." The John Hancock Alternative Asset Allocation Fund (JAAIX) has a 1.56% annual expense ratio.
REALLY BETTER FOR PROVIDERS
Even after the expert panelists’ thoughtful and detailed discussion, I was unmoved.
Alternatives are far better for the providers than for clients. Many of these alternatives have zero or negative expected returns after costs. For example, before costs, not a penny has ever been made in the aggregate on managed futures. Market neutral funds deliver money market returns before costs, but with far more volatility.
To deliver on the promise of higher risk-adjusted returns, you need more than low or negative correlations — you need a reasonable positive expected return. As I tell my clients, they could take half of their portfolio and gamble in Las Vegas. Though it would have no correlation to stocks or bonds, that doesn't mean it's a good strategy.
