#6thIWMC 2021 – THE ALLOCATOR’S EDGE: Challenging the Conventional Wisdom of Portfolio Construction by Embracing Alternative Investments

Philip is writing a book titled – ‘Allocator’s edge’ lined up for the release in November 2021. In this session, he started by giving a context of how he got into writing this book in order to highlight his views on the topic. Phil is a part of financial services since 2007, avid collector and reader of finance books, started writing his own investing blogs and later was proposed for writing a book. However, he chose to write a book on alternative investments as he believed that he wanted to write on something which turn can turn out to be a same answer to both the below two questions-

1). What he was passionate for?, and
2). What people need?

Philip has realized over his career that including alternative investments and setting expectations from the portfolio is challenging for allocators. There is a gap between theory and implementation of strategies around alternative assets. Speaker firmly imparted that financial professionals need to move beyond conventional 60:40 rule of investing and explore the opportunities in alternative mediums. This traditional model of investing, though easy, can be challenging in coming years as per the speaker. Thus, emphasizing the need for allocators to re-think the portfolio composition. Further, in order to clarify the concept on how to build better portfolios, Philip asserted that it is important to firstly comprehend the –  why, what and how behind alternative investments. Also, the same approach has been described  by the speaker in his upcoming book.

Why Alternative Investments?

Philip asserted that in coming decades, owing to potentially lower yields on bonds or higher equity valuations, clinging to stocks and bonds style of investing may lead to lower returns and more realized volatility. However, speaker convinced that with times, market has evolved and the instruments available to investing public has increased drastically. Adoption of alternatives can provide broader toolkit for investors as compared to last decades. So, to build better portfolios, alternatives have been suggested to be explored deeply.

What should be looked at in Alternatives’ Environment?

Philip regarded alternatives as a pretty loaded world with different interpretations. It’s a vast universe with varied asset classes and investing strategies, unrelated to each other. In past alternatives were associated with private equity, hedge funds, commodities, or real estate. In modern world, alternatives now include more accessible tools for retail investors as well; including private credit, farmlands, timberland, digital commodities, cryptocurrencies to name a few. Thus, the speaker outlined that alternatives are evolving and serving different purpose of investors like never before. Thus, keeping the customers’ need at center, allocators and wealth managers are advised to consider allocating some portion of client’s portfolio in alternative asset class. However, blindly adding alternatives without analysing client’s risk and return appetite is not suggested.

How to combine Alternatives in Allocations?

Philip believes that understanding nature of different alternative investments and client’s risk-return appetite can help allocators to judiciously plan the weightage of alternatives’ allocations in a portfolio.

Communication is essential

Philip commented that the portfolio that looks very different from the peers is actually very difficult to hang on at times. Clients might have conviction of alternatives adding value in longer term but may become doubtful in short run. Therefore, he was of the opinion that there is a need for financial advisers and allocators to carefully communicate the investment strategies of particular alternative asset effectively to the clients. He further added that its high time for allocators to make unfamiliar, familiar to clients.

Stop admiring the problem and start doing something

Philip believes that though allocators’ actively hear that 60:40 rule of investing may become less profitable in coming years, they hesitate to include alternatives in the portfolio as the former rule of investing is still fetching results for some and is comparatively easy to achieve. Huber recalled the performance of traditional portfolio in the decade of 2000s when S&P was yielding negative returns. Also, on the other hand, in 2010s, this conventional portfolio model booked abnormally high returns and low volatility. Furthermore, he added that such dynamics should not be expected to continue in longer terms and thus mean diversions should be accounted for when volatility can be high and returns can be low. Though not predicting hyper inflation in coming years, Huber was of the opinion that inflation poses higher risk as compared to couple of years ago which can impact diversification impact of a portfolio consisting of stocks or bonds pnly. Again, highlighting the importance of mindfulness for allocators and including some subsets of alternatives in a material way.

There is no size fits all for alternatives benchmark

When asked if there is any suggested thumb rule over 60:40 stocks and bonds portfolio for including alternative investments for the allocators, Philip asserted that there is no fixed proportion, or one size fits all recommendation for alternatives. But he mentioned that as a professional, he intends to see alternatives in around 10%-30% range in the client’s portfolio. However, he added that for some clients, alternatives just do not fit their portfolio, so may have no allocations for the same. Thus, the speaker communicated careful analysis of client’s needs over blindly including alternatives in the portfolios.

DIY goals of alternatives

For the speaker, alternatives help in achieving DIY goals of a client which stands for Diversification, Inflation and Yield. Further to this, he added that alternatives fill the gap where stocks and bonds fall short. Bonds are not always the appropriate diversifier in the portfolio against equities as perceived in conventional portfolio model and thus Philip asserted that adding alternatives can fulfil this need for diversification in the portfolio where the asset classes or risk factors can be uncorrelated. In addition to this, for the investor  who are susceptible to higher inflation, alternatives like real estate or commodities can prove to be a good complimentary allocation. Lastly, Philip mentioned rates are low across the globe whilst investors are looking reliable source of income to support their multi-decade retirement expenses to which, he advocated active adoption of non-traditional or newly evolving income strategies to the allocators.

At the end, Philip intently answered some of the viewers’ questions regarding different tools for alternatives allocation in a portfolio, costs of portfolio construction, cost-benefit trade off of including alternatives, and also touched on the topic of cryptocurrency and NFT as an alternatives.