“The time to build an ark is when the sun is shining.” – God.
If you understand the purpose of including alternatives in your investment portfolio — seeking improved risk-adjusted returns — you almost certainly understand that your chances of predicting when markets will move up or down is slim to none. Indeed, the past twelve months have seen the stock market climb steadily as investors execute a risk-on trade fed by continued encouragement from Fed policy, contained European debt crisis (for now), and tired acquiescence of extremely slow growth in the U.S.
But once you step back and take a look at the bigger picture, your perspective on where the equity market is, and what direction it’s heading in next, may change. The S&P 500 Index is hovering around levels we haven’t seen since April of 2007.
Of course there are dozens of arguments, both technical and fundamental, for how long this trend will continue. And likewise, there are dozens of arguments for when the trend will reverse. But one thing’s for sure. Though many will make a living pondering WHEN the next down market will occur, no one will argue IF it will occur.
Over time, alternative asset classes like commodities, currencies, and managed futures deliver a significant degree of non-correlation to the both domestic and international equities markets. When used to complement a portfolio of stocks and bonds, they may be just the right solution for improving their risk-adjusted returns.
Correlation1 of Major Asset Class to the S&P 500 (1993 – 2012)
Source: Bloomberg. Date range: 1/1/1993 – 12/31/2012. Indices: Equities – S&P 500 Index; International Equity – MSCI EAFE Index; Hedge Funds – HFRI Fund Weighted Hedge Fund Index; Emerging Markets – MSCI EM Index; REITs – FTSE NAREIT All Equity REITs Index; Commodities – Dow UBS Commodity Index; Bonds – Barclays Capital U.S. Aggregate Index; Currencies – Barclay Currency Traders Index; Managed Futures – Barclay CTA Index.
Alternative asset class investments offer true diversification away from equities. That non-correlation, and independent return stream can potentially act as a buffer for weathering the next market storm.
Now is the time to consider alternatives for your clients with substantial assets to protect.
1 Correlation – A statistical measure of how two securities move in relation to each other and ranges between -1 and +1. A correlation of +1 indicates the two returns move perfectly together, 0 indicates movements are random, and -1 indicates opposite movements.
Diversification does not ensure profit or protect against loss.