Sixteen. Completing the Picture
For the general population, the Internet seemed to explode from nowhere. The first time many heard of it was during a speech by then Vice President Al Gore at UCLA in 1994, which referred to a new “information superhighway.”184 Although in wide use just a few years later, the roots of the Internet can actually be traced as far back as 1962, when J.C.R. Licklider, an American computer scientist, first introduced the concept of a global network, “...where everyone on the globe is interconnected and can access programs and data at any site from anywhere.”185
184 Vice President Al Gore, “Remarks Prepared for Delivery by Vice President Al Gore,” Ibiblio, 1994.
185 Computer History Museum, “Internet History,” 2004.
Licklider then took the lead for the Advanced Research Projects Agency Network (ARPANET), run by the U.S. Department of Defense, in the late 1960s. Throughout the 1970s and 1980s, ARPANET continued to advance, but the general public still lacked access to all the possibilities the Internet could provide.
That is until Marc Andreessen, an undergraduate student at the University of Illinois-Champaign, created a graphic browser, dubbed Mosaic, in the early 1990s. Andreessen teamed with famed Silicon Valley entrepreneur James Clark and later changed the name to Netscape.186 The modern Internet was born.
186 Bio: True Story, “Marc Andreessen Biography,” 2013.
More than 245 million U.S. residents (78% of the U.S. population) used the Internet, as of 2012.187 As I noted, even though the Internet had been around in one form or another for decades, it wasn’t accessible to the general public until developers saw a need for the technology and developed new ways for it to be accessed.
187 Internet World Stats, “Internet Usage and Population Statistics for North America,” June 30, 2012.
The same can be said of alternative investments. Sophisticated strategies that make up alternative investments have been employed by a select few since the 1950s—including high-net-worth clients, institutional investors, and endowments.
Yet today, due to increases in technology and correlation and a number of other reasons previously discussed, they appeal more to the retail investor. Mutual funds, ETFs, fund of funds, and other products and strategies are vehicles retail investors can use to gain access to alternatives.
So What Now?
It isn’t that alternative strategies are new. It’s that new access vehicles are available to the everyday investor. As with traditional investments, some products and strategies will appeal to those with higher risk tolerances and some will appeal to those with lower risk tolerances. It all depends on the individual situation and investment objectives and how they may or may not have a place in the portfolio.
So if there is one thing to take from this book, a case has been made for considering alternative investments as a portion of the portfolio.
10 Important Points to Remember
1. Longer life spans mean a corresponding need for additional accumulation and a variety of sources of income to accommodate a longer retirement. Whereas it was once satisfied and managed by defined benefit pension plans, the advent of 401(k)s placed more of this responsibility on individual investors and their financial professionals and less on the employers. This increase in demand challenged retirement plan providers, money managers, product providers, and pretty much the entire industry to look for methods to allow investors to seek an appropriate portfolio allocation.
2. Prudent planning is no longer a luxury, but a necessity, and the process is far from easy. High correlation among asset classes in recent years means you may not be as diversified as you think. Investments that are untethered from stock and bond markets are increasingly important for two reasons: risk and return.
3. Ultimately it’s about the latter. It’s no longer equity versus fixed income or large-cap versus small-cap; if all asset classes become highly correlated, none of it matters. To be diversified one might consider the concepts discussed in this book—concepts such as correlation, volatility, market exposure, beta, and leverage. These are the influencing factors of investment risk and return and therefore influencing factors of diversification. When implemented, alternative strategies can help improve diversification with the potential to improve long-term returns. Remember, a proper investment strategy is not just about chasing returns (performance), it’s also about managing risk. There is no guarantee that an investment strategy will be successful. Investing involves risk, including loss of principal.
4. Less volatility might be a welcome relief for investors; absent that, strategies that capitalize on volatility can be used to the investor’s advantage. Globalization, growth in developing markets, and advances in communication technology masquerading as the hot, new thing have all contributed to a significant increase in volatility in recent years. So called flash crashes are an increasing and legitimate concern, and something as trivial as a false story in a hacked Twitter account can send markets reeling.188
188 Maureen Farrell, “High-Speed Trading Fueled Twitter Flash Crash,” CNN Money, April 24, 2013.
5. The economic crisis of 2008 saw an $11 trillion drop in household wealth,189 loss of savings, and an increase in sequence-of-return risk. Yet certain, non-correlated asset classes performed better than the overall market during the same period, with some performing less negatively, while others were able to eke out positive returns.
189 Emily Kaiser, “U.S. Household Wealth Falls $11.2 Trillion in 2008,” Reuters, March 12, 2009.
6. Use of alternative strategies in a portfolio is not for everyone. Educated investors can evaluate an alternative investment manager or strategy based on their own financial goals. By constantly scrutinizing the manager or strategy through the lens of your goals, rather than against a standard investment benchmark, performance can be measured over time. If you prefer, you can always seek the guidance of a financial professional to help guide you with these important investment decisions.
7. Alternative strategies are technical, and a certain level of due diligence may be warranted. Arbitrage, or capitalizing on differences in the pricing of the same security in different markets, seems obviously technical. While commodities may seem less technical because they are goods we all easily recognize like timber, coffee beans, precious metals, and wheat, they are perhaps more complicated and may require more intensive research.
8. In the investment world, the term leverage is defined as using borrowed capital, which could also lead to the risk of loss. Like a heavy load that requires additional force (remember margin), one’s financial position and return potential on investment can be similarly enhanced with the help of a lender to provide capital and therefore increase buying power.
9. But caution is strongly advised. Leverage is a strategy that can amplify returns, losses, and volatility, but often only results in the latter two. It requires a significant amount of expertise.
10. There are many types of hedging strategies: market directional, corporate restructuring, convergence trading, and opportunistic. All must be considered to ensure suitability for yourself. Again, a financial professional can help.
We could go on, but my point is not to recount the entire book; rather, it’s to illustrate the importance of looking to include alternative assets in an investment portfolio. What are the goals for your investment portfolio? Is it a certain percentage return that’s compounded annually, or funding a grandchild’s education? Is it finding the latest investment opportunity or is it a dream vacation with a spouse? Alternative investments may help with these goals. Financial professionals stand ready and willing to help, offering expertise in a seemingly infinite number of specialty areas.