Navigating Alternative Investment Strategies

For years, stocks and bonds have been the primary way investors could build their wealth. However, we’ve seen remarkable transformation in a third venue: alternative investments, loosely defined as any financial investment that does not fall under the traditional stock or bond categories.

While some alternative strategies have been around for decades, four areas we find intriguing for client portfolios include: Real Estate, Private Lending, Reinsurance, and Style Premia. 

Buckingham’s Investment Policy Committee (IPC) has taken a measured and cautious approach to adding alternatives to our portfolios. Although we remain skeptical of most alternative strategies, we’ve found a few that may benefit a well-constructed portfolio. It’s important for investors interested in alternatives to understand how the space has evolved, the framework the IPC employs when evaluating strategies, and the potential benefits and risks of investing in the various alternative asset classes.

Evolution of the Space

Over the last 20 years, we’ve seen a few notable improvements in the investment landscape for alternatives.

• Structure: More alternative strategies are now available in publicly registered, SEC vehicles, so investors are no longer limited to the limited partnership space. This is good from a fee, transparency and liquidity point of view.
• Fees: Although the strategies are still more expensive than most stock and bond funds, increased competition has brought fees down to more reasonable levels.
• Opportunity: Finally, changes in market structures have opened new avenues for investors. Technological improvements have allowed for significantly faster underwriting for consumers and small business loans, and changes in legislation, such as the Dodd-Frank Act, have shifted incentives for large banks, opening new lending opportunities for private investors.

Evidence-Driven Investing^TM Criteria

We practice an evidence-driven approach to investing, which simply means that our recommendations are not based on my opinion or the opinion of any individual, but rather they’re based on decades of academic and practitioner research. When evaluating alternative strategies, we look for certain characteristics across the funds and managers we recommend:

• We look for strategies that don’t move in tandem with stock or bond markets. We look for investments that are exposed to a unique set of risk compared to stock markets.
• Although performance over shorter time frames will vary significantly, we expect investments to have better returns, on average and over time, than our high-quality bond portfolios.
• Finally, like everything else we invest in, we look for strategies that are systematic, transparent and repeatable. Our investment recommendations are backed by research that demonstrates economic or behavioral reasoning on why we should expect the premium to continue.

Those simple criteria create a high hurdle that most alternative strategies do not currently pass.

Impact of including

Ultimately, we know alternative investments are not right for everyone. Compared to the stock and bond funds we recommend, alternative funds are more complex, more expensive and can be less liquid, which means that investors are sometimes restricted to how much and how often they can withdraw their money. Finally, alternative investments can experience significant declines, and speaking from experience, the more complex the strategy, the harder the declines are to endure.

For those able and willing to stomach the risks, however, adding alternatives may cushion the portfolio from the unpredictable (and sometimes severe) declines in the stock market while offering a potentially greater chance for portfolio growth compared to high-quality bonds.

Index data shows that compared to a conventional mix of 60% global stocks and 40% bonds, alternatives improve the portfolio experience. If the allocation was pulled from bonds, the portfolio experienced higher returns over the last 30 years with similar downside during the 2008 financial crisis. If the allocation was pulled from stocks, the portfolio didn’t grow quite as much but experienced less severe declines and recovered faster during the 2008 financial crisis.

Learn more about alternative investments and Buckingham’s investment philosophy on The Optimal Mix of Investments. You can also speak to your financial advisor for more information.

Chart sources: Ken French Data Library, Morningstar Direct. For illustrative purposes only. The first chart illustrates the hypothetical growth of $1 million over the 30-year period ending in December 2022, and the second chart illustrates the hypothetical performance of $1 million invested at the October 2007 market peak and held through the Great Financial Crisis.

Index Composition information: 60% Global Stocks, 40% Bonds is composed of 36% U.S. Stocks, 18% International Stocks, 6% Emerging Market Stocks, and 40% Intermediate Government Bonds. 60% Global Stocks, 15% Alternatives, 25% Bonds is composed of 36% U.S. Stocks, 18% International Stocks, 6% Emerging Market Stocks, 15% Market Neutral, and 25% Intermediate Government Bonds. 45% Global Stocks, 15% Alternatives, 40% Bonds is composed of 27% U.S. Stocks, 13.5% International Stocks, 4.5% Emerging Market Stocks, 15% Market Neutral, and 40% Intermediate Government Bonds. U.S. Stock returns are represented by the total U.S. market return, from the Ken French Data Library. International Stocks are represented by the total developed international market, from the Ken French Data Library. Emerging Market Stock returns are represented by the total emerging market, from the Ken French Data Library. Market Neutral is represented by CISDM Equity Market Neutral Index, from Morningstar. Intermediate Government Bonds are represented by the Ibbotson Associates U.S. Intermediate Government Total Return Index from the Stocks, Bonds, Bills, and Inflation (SBBI) data, from Morningstar.

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. The indices do not represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Index total return includes reinvestment of dividends and capital gains.

Alternative investments may not be suitable for all clients. Individuals should speak with a qualified professional to review the risk characteristics of alternatives and determine their appropriateness based on each individual’s circumstances. Alternatives have a unique set of risks including but not limited to limited ability to withdraw investment, higher complexity compared to traditional stock and bond investments, potential for significant equity-like losses, and higher expenses.

For educational and informational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third-party data and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy of this information. Buckingham’s Investment Policy Committee (IPC) is a committee comprised of Buckingham Strategic Wealth, LLC and Buckingham Strategic Partners, LLC (BSP) (collectively Buckingham Wealth Partners) and determines investment-policy-related decisions, which independent members of the BSP community may adopt. EVIDENCE-DRIVEN INVESTING™ and DESIGN | BUILD | PROTECT® are trademarks of Buckingham Strategic Wealth. All rights reserved. R-23-5702

The content of this article was written by a third party, not an employee of Northwest Wealth Management.