SINCE THE STOCK MARKET PEAKED IN October 2007, the bear has been clawing investors. Bonds have delivered scant returns, and naturally, mutual funds holding these traditional investments have fared from so-so to sorrowful.
Fortunately, investors have options. There are many “alternative investments” from which to choose. “Investors might hold 10% to 25% of their portfolio in alternative investments,” says Peng Chen, president of Ibbotson Associates, a subsidiary of Morningstar.
Nancy Little, an auditor with General Motors in Detroit, says she wasn’t impressed when her financial adviser initially approached her about shifting some of her assets into alternatives. “After he explained the benefits to me, and I did some research on my own, I understood how holding oil, precious metals, and other commodities could actually reduce my overall risk,” says Little, 57, who is hoping to retire within the next two years. “I put about 25% of my portfolio into alternative investments in early 2007, and they’ve done better than anything else I own.”
Little owns a commodities fund, a weakening dollar fund, a managed futures position, and gold bullion. Year to date, these investments have returned 14%, close to 1%, -2.5%, and about -1%, respectively. While the investments’ combined performance is less than stellar, it still bested the S&P 500 (down 13%) and international markets, which are down 20%.
According to Little’s adviser, Ivory Johnson, director of financial planning at The Scarborough Group, an investment advisory firm in Annapolis, Maryland, alternative assets actually reduce a portfolio’s risk. In fact, a portfolio with a 20% allocation in alternative assets from 1998 to 2007 increased average returns by 11.7% and reduced risk, as measured by standard deviation, by 14.6%, when compared with a traditional equities/bonds portfolio. Moreover, Little has a 40-year time horizon, since people are living longer.
Little is one of millions of investors who are diversifying their portfolio by going outside of the traditional stocks, bonds, and mutual funds and into the worlds of commodities, financial derivatives, hedge funds, and other vehicles. These alternative investments could provide valuable diversification in these tough times—but only if done right and if used in moderation.
AGAINST THE GRAIN
International, emerging markets, and small-company stocks all tended to move in the same direction as large-company