Can Alternative Investing Rescue Your Retirement?

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

It is no secret that the last decade has been a tough one in which to make money in the stock market.

But you may be surprised to learn that this period of underperformance stretches farther back than just since the 2008 global financial crisis.

In the 20 years up to 1999, the average real total returns from stocks (dividends plus capital gains) stood at 13.1%.

Last year, total return on the S&P 500 was just 1.25%.

The 15-year average annual return — roughly since the dotcom bubble burst — has fallen to 5.42%.

That’s just over half of the roughly 10% average annual return for the S&P 500 since its inception in 1928 through 2014.

Nor does the next 20 years look particularly encouraging.

After all, the U.S. stock market is trading at a long-term Cyclically Adjusted Price/Earnings Ratio (CAPE) of around 26 — far above its long-term average of 16.7.

If you rely on income from your investments, you have it even worse.

Conventional wisdom was that after the Fed slashed interest rates in the post-crash era, they would quickly rebound.

Today, a new conventional wisdom is emerging that low interest rates are here to stay for a long time.

A long period of low interest rates is not unprecedented.

After the Great Depression, U.S. short-term interest rates first hit 0% in 1932.

They didn’t climb back above 1% until 1948 — an astonishing 16 years later.

History does not repeat itself. But it does rhyme.

If the same pattern holds this time, interest rates may not hit 1% until 2024.

Low interest rates wreak havoc across the financial spectrum. Pension funds cannot meet defined benefit obligations. Retirement savers are punished, sentenced by loose monetary policy to a lower standard of living than they ever expected. Rising interest rates make refinancing high levels of government debt unaffordable.

The rule of thumb used to be to assume a 4% return on your assets in retirement. If you had a $1,000,000 pension pot, you could count on a safe income of $40,000 a year. That’s hardly a king’s ransom.

But today, the number is closer to 2.5%.

That implies income of $25,000 per year, pushing even those with $1 million in the bank below the poverty line.

Alternative Investing to the Rescue?

Enter the world of “alternative investing.”

Alternative investing was first made popular by Yale University’s endowment chief David Swensen starting in 1985. While top U.S. universities were early adopters of this model — and have stuck to it despite coming under pressure in the post-crash era — Swensen’s approach has been widely emulated by pension funds and sovereign wealth funds around the world.

Swensen’s fundamental insight was to shift Yale’s standard asset allocation strategy from 60% U.S. stocks and 40% bonds to a widely diversified mix of assets.

Today, Yale has a whopping 67.5% of its endowment invested in “alternative investments.” This includes 27.8% in real assets, 23.3% in hedge funds and 16.4% in private equity. And Yale has been rewarded for its unconventional strategy, with venture capital — as a subset of private equity — reportedly generating an average 18% annual gain over the past 20 years.

By way of contrast, Yale’s investments in the U.S. stock market have fallen to a mere 4% of its target portfolio.

That means that Yale is betting only $1 out of $25 on the asset class that most U.S. investors have the bulk of their assets in.

So, What are ‘Alternative Assets’?

With that, here is a quick introduction to “alternative assets.”

1. Private Equity

Private equity includes a range of investment strategies, including venture capital, buyouts and mezzanine financing. Venture capital (VC) backs the efforts of entrepreneurs. Successful VC is responsible for the massive returns of Google (GOOGL) and Facebook (FB) — and even Uber, which just received a $66 billion valuation. Buyout strategies provide funds to acquire established businesses, whether they are stand-alone or a spinoff of a larger business. Mezzanine financing is a mixture of debt with equity: high-interest-rate lending topped off with warrants or conversion rights that provide additional upside.

2. Real Assets

Real estate accounts for the biggest chunk of real assets. But real assets also include more unconventional assets such as farmland and timber. GMO chief Jeremy Grantham’s favorite asset class is timber, which has generated a steady return of 6.5% plus inflation over the past century. The Harvard endowment even owns forests in Romania.

Real assets also include intellectual property. “Bowie Bonds” are an asset-backed security which uses the current and future revenue from albums recorded by musician David Bowie as collateral — a form of financing that rivals the late artist’s creativity in music.

3. Commodities

Commodities are simply raw materials used in the production of goods and services. The primary focus in commodities investing is on futures markets where the large majority of commodities trades are executed. Futures markets are also the primary way in which commodities are priced.

You also can invest in commodities through direct ownership — think gold bars — or by investing in an exchange-traded fund (ETF) or mutual fund that focuses on commodities-based stocks.

4. Hedge Funds and Managed Futures

Hedge funds cover a wide range of investment strategies such as convertible arbitrage, global macro and currency, fundamental long-short and quantitative strategies designed to wring out profits from the inefficiencies in the market.

Managed futures, known as commodity trading advisors (CTAs), are professionally managed funds investing in global futures and other derivative instruments. CTAs take long and short positions in commodity stocks, fixed income and currency futures. CTAs are attractive because what they do makes them less correlated to the stock market.

What is to be Done?

If you have a hard time getting your head around some of these asset classes, don’t worry. You’re not alone.

Each of these is an asset class or strategy that far exceeds a simple buy recommendation on a stock.

And each is also beyond the expertise of most brokers or financial planners.

Still, alternative investing is also the way forward in eking out better returns in a world where publicly traded markets are overvalued and interest rates are essentially zero.

And if you participate in a large pension fund, chances are some of your money is already invested in these strategies.

Access to alternative investments for retail investors is difficult, if not impossible.

But there are a handful of ways that you can get exposure to these asset classes through various listed companies and specialized ETFs.

I’ll be discussing some of these ways in future issues of The Global Guru.

In case you missed it, I encourage you to read my e-letter column from last week about the growing economic potential of Vietnam on the world stage. I also invite you to comment in the space provided below.

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