Defining Alternative Asset Classes

Includes: DBU, DXALF, EFA, SPY
by: Roger Nusbaum

What would you include in alternative assets? What would you like to see that does not already exist in the way of accessible alternative assets?

I think getting too hung up on definitions is the wrong approach. I would say to focus more on the result a particular thing delivers and how it gets the result.

First I would say things like wine and art and even my 1971 Roberto Clemente card (I have a collection of like 20 baseball cards) are not really investments easily accessed by a lot of people. I am not saying you can't make money in these things, and I think there is an Art Fund of some sort that exists in Europe, but to the extent these are investments, that is beyond the scope of this discussion.

Dexion Absolute is a publicly traded fund of hedge funds that is listed in the UK under ticker DAB.L but is available in the US (OTC:DXALF).

If you look at a two year chart compared to the S&P 500, there is plenty of zig versus SPX's zag. Maybe there is enough for you or maybe not, but there is clearly some zig. If you find some sort of long/short product, regardless of what it trades, that consistently delivers an non-correlative result, it would likely fit my definition of alternative assets.

The few that I use -- so stressing moderation -- generally deliver a non-correlative result. Obviously you can drill (or bog?) down in more detail but at some point it becomes counterproductive (subjective opinion).

If you think about all the types of products that you know of in this realm like commodity, currency, strategic, toll roads (do these count?) and I'll include hydro funds (I do not own any of these), I can tell you there are plenty more out there that you have never heard of (I seem to find a new one every few days). The chance to find and learn about these is vast. No one will likely be an expert in all of these things. Even if you can come up with a dozen different categories of what you term as alternative, it is doubtful you need more than two or three in your portfolio and even that may be too many.

If you are going to swim in this pool I would suggest being cognizant of the issue of hedging an equity portfolio with a few alternative ideas versus hedging a portfolio of alternative strategies with a few equities.

I'll finish with alternative ideas I'd like to see or see more of. For a while XShares had been on file for the AirShares EU Carbon Allowances Fund. I don't know whether this fund will ever come, but something that accesses the carbon credit market is bound to come, the growth in this market would seem to be substantial and I think the correlation to US equities would be very low.

The concept behind the Macquarie Pastoral Fund is very interesting to me (livestock and farmland down under). This particular product is not exchange traded so I am going to pass, but I believe if it is successful (it is a little over one year old, I believe) there will be similar products that do list on an exchange somewhere.

I like the idea of products tied to economic indicators. The correlation to stocks of this sort of thing is probably high, but some sort of product tied to GDP growth of a basket of emerging markets or frontier markets would be very interesting.

Since 2004 I have talked about the extent to which investment products will evolve to offer the chance for much more sophistication to do-it-yourselfers (this has always been obvious) and I think the pace of this will accelerate. Just because there might be several hundred alternative (assume vague definition) products doesn't mean you need more than two in an attempt to reduce your correlation a little.

Update: After Seeking Alpha ran this morning's post,a reader left a good question. He asked whether international utilities, specifically captured via WisdomTree International Utilities (NYSEARCA:DBU), are better for reducing correlation than a broader foreign product.

Well, the numbers are in and the reader is correct. According to iShares EAFE (NYSEARCA:EFA) has a 0.84 correlation to the S&P 500 while DBU has 0.56 correlation. I would note that DBU, although dividend weighted hasn't actually paid much of a dividend which is frustrating. Regardless of the dividend DBU (which I own for a few clients) has done well, has outperformed both EFA and SPY and does have a low correlation.

The biggest risk, in my opinion anyway, would be if interest rates which are generally low start to go up. A rule of thumb is that rates moving up are bad for utilities as fixed income (talking further out on the curve) competes for some of the money that goes into utilities. I think higher rates further out on the curve would be a positive for equities as that might signal a return to normal but it sets up utilities to, at a minimum, lag a little.