Alternatives a solution to high correlations

When diversification among traditional asset classes isn’t working, try adding alternatives, said a panel at an Alternative Investment Management Association of Canada event in Toronto.

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Fabrice Morin, principal at McKinsey & Company in Montreal, notes these investments fall into three main categories: hedge funds, private equity and assets such as real estate, agriculture, timber and infrastructure.

Alternatives are getting significantly more attention among affluent retail clients in the wake of 2008, his research shows, because such investments aren’t correlated to the broader market.

Craig Machel, a portfolio manager at Richardson GMP in Toronto, said retail advisors can look to institutional players for guidance on how to position alternatives in client portfolios, while remaining mindful of important differences between the two client types.

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Alternatives are inherently more complicated than traditional asset classes, noted Steve Vogt, chief investment officer at Mesirow Advanced Strategies Inc. in Chicago. This is true not only of the structure of these investments, but also of client access: buying into alternatives often means signing on to a limited partnership or LLC.

But advisors must translate the investments’ complexities into ordinary language. “If you can’t explain it clearly to your father, it’s probably not a good investment,” said Vogt.

The appeal of alternatives goes beyond downside protection, he adds. On a cyclical level, we’re at a point where risk assets have had a fairly strong run; on a structural level, rates and yields remain low. “So how can I get something for my balance sheet without having to walk off the edge of a cliff in terms of taking additional equity market risk?” Vogt says alternatives have become more attractive in part because they address this problem.

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The panel also discussed the issue of fees and the response of central banks to the crisis.

On fees, Morin notes a structural shift in the retail space both in Canada and the U.S. “Pricing is tied less to products and transactions, and that’s more conducive to advice.”

Vogt says that overall Bernanke and other central bank heads responded well to the crisis. But he warns of the next one: “The next crisis is not going to be because of a leverage problem—that will be taken care of. It’s going to be about a liquidity problem.”

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