Today, we talk about an area of the market that many people have heard of, but haven’t chosen to invest in as of yet. Specifically, we’re talking about “Alternative Investments” - investment strategies that are different from and diversifying to, traditional asset classes. In this first half of this two-part episode, our own Tom Romano is joined by Symmetry’s Phil McDonald, CFA, CAIA, Managing Director of Research Investments & Portfolio Manager, to further define what “Alternative Investments” are, and why you may want to consider their potential benefits.
If you have any questions or would like more information, reach out to us at https://symmetrypartners.com/contact-us/
You can also find us on Facebook, YouTube, Twitter, and LinkedIn. As always, we remain invested in your goals.
Symmetry Partners, LLC, is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered, excluded or exempted from registration requirements. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. No one should assume that future performance of any specific investment, investment strategy, product or non-investment related content made reference to directly or indirectly in this material will be profitable. As with any investment strategy, there is the possibility of profitability as well as loss.
Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions.
Please note the material is provided for educational and background use only. Moreover, you should not assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice.
Transcript
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Hello and welcome to Unfiltered Finance. This is your host, Tom Romano.
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Thank you for joining us. Uh,
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we have a special episode today where we want to talk about, uh,
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an area of the market that, uh, a lot of investors have probably heard of, uh,
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and probably most investors don't have a lot of exposure to.
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And that is alternative investments.
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And I have the perfect guest for us here today. Uh, Phil McDonald,
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who is a portfolio manager and the managing director of investments at Symmetry
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Partners, and is the resident expert on,
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on alternative investing here at Symmetry. So Phil, thanks for joining us today.
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Thanks for having me. I'm happy to be here.
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So I kinda wanna start very high level, Phil, um,
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because I think alternative investments is a, is a very, very broad topic.
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I mean, it can cover things, uh,
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such as precious metals to hedge fund strategies, um,
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all the way down to things like NFTs, right? Or, or even, you know,
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card collecting to an extent, right? So if you could just very high level give,
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give us a very broad definition, uh, on your view on alternative investing,
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please.
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And thank you that,
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that is a highly relevant question because alternatives is one of those labels
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and investing that doesn't have, uh,
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a perfectly agreed upon definition. I think, you know,
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certain people hear it and they think different things. Um,
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I think a useful definition to keep in mind is really, uh,
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the starting point is anything that is an investment strategy that is different
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from or diversifying to traditional asset classes that is
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equity and fixed income, right? Um,
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but I think you can't really stop there because, you know,
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you called attention to, to certain ideas that, you know,
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people might think of if, you know, you mentioned alternative investing,
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you know, baseball cards or, you know,
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a lot of interesting different artwork choices. Yeah. We've talked about,
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talked about
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That before.
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Cars, uh, timber farmland, you know, these are all, some,
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a lot of people think real estate, right? Which I think we could,
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we could debate that one,
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but I think not only should the investment strategy be different, but there,
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there should be kind of an economic rationale for why you might
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earn a return on that different strategy. And, and more specifically,
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where's the premium coming from? Right? So I think very quickly for me,
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that collapses down more to specific liquid,
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uh, investment in trading strategies.
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Sometimes based on themes we're al already familiar with in,
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in asset classes we're already familiar with.
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You don't necessarily have to go really far a field to find an
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addition to a portfolio that will, will make a difference in terms of, you know,
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adding an alternative, uh, investment exposure.
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Sure. Thank you for that. And, um, you know,
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I think it is that broad of a definition, right? I mean, uh,
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just to sort of clarify for, for our listeners, um,
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the word alternative means alternative, you said traditional asset classes,
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stocks, bonds.
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There is a correlation benefit to owning both stocks and bonds in a portfolio
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Most years. Most years. Yeah. We'll get to that. We will get to that. Um,
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however, um, you know, alternatives, to me it is a,
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it's a correlation story in, in all of those investments, if you will,
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whether it's cars, stamps, baseball cards, commodities,
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they are going to have or should have some sort of diversification benefit.
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And that's the purpose of it, right?
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Totally. You, you nailed it.
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The diversification benefit of an alternative strategy performing alternatively,
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right? So if you wanna get a little bit geeky, you know,
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you can think about something whose return stream looks different. So, you know,
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low correlation and expected return from that, you know, economic logic,
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that underlying fundamental theme as to if I do this trading strategy,
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I should expect a return, hopefully lower volatility than, than say,
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a equity market. So right there, you, you can talk about high sharp ratios or,
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you know, high excess returns relative to the volatility you're talking about.
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And, and absolutely diversification is the benefit. Very often, I, I, you know,
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use the, um, analogy of, you know, a third bucket of diversification.
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All you thought really all you had was two, well,
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there's this third bucket you might want to consider for some clients. And,
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and one, one thing I want to clarify here on, on this topic while we're here,
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most of these strategies are not a hedge,
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diversification is not a hedge.
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So if you're diversified with regard to, you know,
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equity markets and volatility, it doesn't mean when equities go down 10%,
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you go up 10%. It's not that directly, you know,
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inverse of a relationship. It's unrelated, you know,
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it's not sensitive to what the equity or fixed income market hopefully is doing.
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That's really what diversification is.
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So it's not the taking the, the counterpoint, if you will, right?
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Like something zigs this must zag, so to speak. Right? And so the idea is, it,
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it's not going to behave from a return standpoint like any other,
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it shouldn't behave like any other asset classes you currently have in your
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portfolio. And I really like the way you put that sort of a, a third bucket,
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right? I I maybe even a fourth, right? Because I think of cash. Yeah, exactly.
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So, so most investors have cash, bonds and stocks,
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most of their 401ks. And so what you're saying,
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there's this whole other realm of alternatives that can have
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diversification benefits because of the fact that they don't behave like stocks,
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bonds, and cash. Correct.
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So let's talk a little bit because I think alternatives sometimes get a bad
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rap. Um, I think a lot of it has to do with the,
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so maybe the broad definition has something to do with it,
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but let's just kind of pick it apart with some of the,
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the arguments I've heard from, uh, investors and financial advisors alike.
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And the first one that comes to mind is cost, right? You know,
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you think hedge funds,
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you think two 20 or three and 30 where you're the managers earning, you know,
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2%, 3% plus a,
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a large portion of the profits talk to us a little bit about cost with
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alternatives,
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Right? And that I think is a fair critique of,
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I dunno if I wanna call it a traditional model of alternative investing,
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maybe older model where some of this, these strategies started mm-hmm.
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Which really only offered in limited partnerships,
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which tend to have high minimums, you know,
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so only high net worth folks can qualify for them. They're illiquid.
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So capital could be tied up for something even up to 10 years opaque,
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you're not really sure what the manager is doing and, and expensive, you know,
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even, you know,
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sometimes you have like fund to funds and feeder funds and you have layers of
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fees, and then obviously those, those performance fees come into play as well.
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Um, so the good news is that that's not the only way to access alternative
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strategies. Now, you,
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the investor is able to invest in mutual funds and even ETFs that offer
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alternative strategies for the most part, liquid, transparent, you know,
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you get all the benefits of, you know, the regulatory requirements of,
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of being a fund in these structures.
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Not all strategies live well in that liquid structure.
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So, you know, you don't have quite literally that list of, you know,
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that funny list of all the things we could think of that someone might think of
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as, as a good investment. So you, you are more constrained,
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but still there's quite a bit to, to choose from. And then, you know,
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to your point,
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most of those strategies are just gonna have a very straightforward expense
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ratio on the fund. It'll be very clear what the investor has to pay on average.
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You typically see higher fees than, you know, a traditional say,
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index fund for equity or, or, or fixed income. But you,
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you're getting something different in, in a well-managed alternative strategy,
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Right? And you hit on a couple of of points there, right?
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Cost is something that always comes up. And uh,
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I understand that even in some of these ETF or mutual fund type vehicles,
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that there, there could be a higher layer of cost,
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but there are ways to get exposures to these asset classes without paying
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two and 20. Mm-hmm. Right. Um, you also mentioned liquidity, right?
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I think that gets solved for,
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if you're not using a limited partnership sort of vehicle.
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If you're using an etf, they're very, very liquid.
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So you can get your money whenever you may need it.
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But you also hit on something that I think is, I think,
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important to investors and it's transparency, right?
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The opacity of a hedge fund, traditional,
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if I can use the word traditional hedge fund tends to be a little bit, uh,
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black boxy, if you will, right? Right. And maybe investors are thinking of,
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you know, things like Bernie Madoff or things like that, right?
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Where you don't know what's going on under the hood,
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but an ETF or a mutual fund,
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an ETF specifically, you're gonna get a a lot of transparency in that. Correct?
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Yeah,
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Absolutely.
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So you know exactly what you're holding.
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Absolutely. And, and, uh, you've touched upon a point,
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which I think is very relevant,
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and thankfully there's been an evolution in the industry to kind of bring
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attention to some of that. So the,
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the idea of a global macro go anywhere,
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hedge fund a star manager who, you know, returned a thousand percent last year,
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you know, raising funds, just like in telling investors, I'm really smart.
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I'm smarter than all the rest. Invest with me.
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I'll find whatever the opportunity is globally, you know,
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regardless of country or region or asset class. Like,
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I will go find that opportunity and I will achieve a higher return. That,
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that's certainly something to probably be very careful of, right? He,
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he might wanna shy away from that. So over the last, I don't know,
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I'll say 25 years or so, there,
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there's been light kind of shown upon this idea that, you know,
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hedge funds don't hedge, you know, some hedge funds have a lot of beta,
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some hedge funds are,
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are implementing strategies you can get with liquid strategies. You know,
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this idea of hedge fund replication was, was an interesting arm of, uh,
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quantitative research. So I, I think for,
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for those who are interested and have the time as an alternative investor, you,
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you should be able to get from your manager a very specific explanation of
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exactly what's happening in the strategy,
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why it's an alternative strategy,
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why the fee being charged on that strategy makes sense,
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how it's diversifying to traditional asset classes. And really, I think at a,
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on a very basic level,
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confirm you're not paying alternative investment fees for
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just call it equity beta, right?
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Because we know equity beta is available in really high quality ETFs from
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Vanguard for probably three basis points. Yeah.
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I think that's a very important point, right? And, and we're firm believers on,
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on, on transparency. And if you're using alternatives correctly,
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if I'm understanding what you're saying,
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and it is a diversification play to ensure that you're getting that
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diversification, you need that level of transparency. And a lot of times, and,
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and we've read about this and talked about this in the past,
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sometimes these more opaque type strategies, you know,
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if equities are doing really, really well,
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they might be very correlated to equities at that very given point in time.
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And then the whole story of diversification kind of goes out the window,
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doesn't it?
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A hundred percent.
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And I think financial media hasn't helped in that education, right?
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So there's been stretches of time when equity markets were doing very well,
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and hedge funds haven't been, and, and you know, the storyline there is,
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you know, hedge funds failed. And well, if hedge fund,
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if a real alternative strategy has zero beta to the equity market and the equity
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equity market's doing well,
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I wouldn't necessarily expect to see those hedge funds up just because,
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Right? If, if the,
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if the alternative investment that you're using for diversification is zigging,
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while your equities are zigging, you
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Should ask questions. You should ask
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Questions. Absolutely. Absolutely. Well, let,
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let's talk a little bit about the performance, uh, of,
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of alternative investing in relation to portfolio.
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And you alluded to this in the beginning when, uh, you mentioned that, you know,
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sometimes stocks and bonds do behave alike. Mm-hmm. And we saw that in 2022,
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right? Yeah. Both had, uh, extremely volatile tough year,
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both ended up in, in the red. Um,
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how did alternatives do, or what,
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how did alternative asset classes perform during that timeframe?
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Uh, certain of them did reasonably well. So, uh, I'll,
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I'll maybe run through a few examples of, uh,
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strategies that are alternative. Uh,
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our diversified alternative investment approach would include.
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One of those is something called, uh, manage futures or trend following, or,
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you know, if you want to think about, you know, quantitative factor investing,
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which you know, is what we think about a lot, you can, you can consider that,
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um, longitudinal momentum or momentum over time.
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And this is really just a strategy that takes advantage of investing in futures
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and forwards. So derivatives that'll cover, you know, commodities,
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equity markets, fixed income markets. Uh, and in the simplest sense,
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if a trend in an asset class is up,
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especially over, you know, short, medium, and long-term time periods,
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the managed future strategy would essentially be long that exposure.
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And if a trend is down over, you know,
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short and long horizon managed future strategy would be short, uh,
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that asset class or commodity. So in 2022,
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when everything felt like it was going down and continuing down,
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the managed future strategy was able to reposition and be short,
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many of those strategies that were showing persistent negative price signals.
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So in 2022 a year when both equity and fixed income markets globally,
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generally speaking on a diversified basis,
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were down and very positively correlated,
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something like a managed future strategy was up, uh, strongly and,
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and very diversifying. That's
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Really interesting.
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And so would you'd have the same expectation if both stocks and bonds were
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up, that the mayor's future strategy might be down, or does it depend?
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It depends.
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So it depends on the strength of those signals and the persistence of those
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trends. So in, in certain stable, neutral, slow,
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generally up markets, those signals may be too choppy to, to make use of.
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And maybe if there's conflicting signals, say, you know,
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up in the short term, down strongly in the medium term,
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up slightly in the long term, you know,
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you can't always make sense of those quantitative signals and,
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and you might have no exposure in that type of underlying market or commodity or
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asset class.
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So that'll conclude part one of our, uh, conversation alternative investments.
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Phil, thanks for joining us. And for our listeners, uh,
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if you're looking for additional information,
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please feel free to visit our website, www.symmetrypartners.com,
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and to access more of the Unfiltered Finance podcasts.
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Please feel free to find us wherever you're getting your podcast today.
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Be sure to stay tuned for part two.
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