With the Dow breaking 20,000 investors are happy with stock related investments, which generally are long the market. But the market won't go up forever, consistently, there will be pullbacks, sell offs - that's how markets work. Even with the Fed's quantitative easing program, a Dow that goes straight up is not healthy. But of course, everyone is happy with Dow 20,000.
As an alternative asset manager ourselves, we admit that we are biased. However, we also have a unique perspective into those who don't hedge, those who don't invest in alternatives. Our business has an exact opposite correlation with a positive stock market. When the market tanks (that is - really tanks, not just a negative day) like we saw in August of 2015 - our phone rings off the hook. Understandably, 2016 was not a great year for our business. It always baffles us why investors wait until it's too late to hedge their portfolio.
Originally, the concept of 'hedge funds' was exactly that - to 'hedge' the market, that hedge funds could buy and sell stocks, and take a position in the opposite direction. But over time, hedge funds just became another tool for managers to execute strategies at their choosing, some for better and some for worse.
First let's take a look at alternative investments, what they are - what kinds of alternative investments are there?
- Managed Futures - Managed Futures represent more than 400 Billion of managed assets - that's not insignificant. The benefits of managed futures is that managers can offer a wide variety of strategies, because futures exist for nearly all financial instruments, including stocks. Managed Futures can be risky, but there's been CTAs like John Henry that have performed well over a period of more than 30 years.
- Alternative bonds - Unlike your traditional bonds, junk bonds (corporate bonds with higher yield) can be attractive if offered by companies with high credit ratings. Other alternative bonds such as tax free munis, offer tax incentives (no tax on profits) thus increasing the total yield. Listed bond funds offer access to such bonds.
- Multi Currency - Emerging market funds themselves perform as multi-currency funds, because they are heavily invested (unhedged) in emerging market currencies. Currency markets are good alternative investments because major currencies don't fluctuate too much, but often are against the correlation to stocks. For example, while the market was going up during the election, so was the US Dollar, and the Japanese Yen was going down.
- Private Equity - Private equity is becoming more mainstream, with tools like crowdfunding allowing average investors access to markets that previously were only for accredited investors. However, Private Equity is very risky and should really only be considered by sophisticated investors, or with money that the portfolio could afford to lose ('risk capital')
These are just a few examples. The point is that, there are a huge amount of alternative investments, and generally speaking, portfolios are light on alternatives. Some portfolios, have no alternatives and those that do, generally have about 30%. This also makes the market top heavy; as the majority of investors are in stock-long funds and instruments, everyone wins together and loses together.
Not only do alternatives provide a 'hedge' against a declining market, many of them may over perform other investments. Many alternatives are what they call 'market neutral' which means they may perform well whether the market is going up or down.
Of course, investors should do more due diligence than usual on alternatives, especially if it's something they've never done before. But dollar for risk dollar - it is prudent for investors to include alternative investments in their portfolio.
Fortress Capital believes that because of unknown risks in the "Trump Call" as some are calling it (pro-American policies) investors will seek alternative investments like never before. Generally, Trump will be positive for stock markets, as we've seen. But individual investments, may have unforeseen consequences. For example, take a look at Amazon (NASDAQ:AMZN) - it's a tech powerhouse. Such companies rely on trade with China, and Trump can make that difficult. A company like Amazon will certainly adapt - but how they will do it, and what impact it will have on their foreign operations - remains unknown. Simply put, Trump inserted an element of 'unknown' in the markets, mostly positive, but negative too. Even if you're a self-professed expert in Trump policy and how it will impact the market, the bet here isn't about understanding Trump, it's about how the market perceives they understand Trump, which is always the most tricky part to analyze.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.