We've all heard that it was impossible for anyone to make money in 2008. Every asset class suffered terrible losses and there was nothing financial advisors could have done to cushion clients' portfolios. Apparently, no one told this to the investment managers of Harvard University's endowment. They notched strong returns last year to the tune of 8.6%.
How is this possible? For a long time, Harvard's endowment managers have known what the rest of us are truly beginning to realize: Alternative investments make for good strategy.
In recent years, alternative investments such as commodities, hedging strategies and currencies have become increasingly popular. The innovation of alternative mutual funds and exchange traded funds has especially made these types of investments more accessible for financial advisors. Yet as their name suggests, until now alternative investments haven't been core holdings for most retail investors. It's only with the disastrous performance of just about every equity mutual fund in 2008 that we've seen how outdated the traditional asset allocation methods are.
In other words, the new market reality is now. And it means that the old "style boxes" are dead.
At our firm, Gemini Fund Services, we are witnessing this trend first hand. Gemini has been in the business of helping investment advisors create and service pooled investment solutions for over 20 years. Today, the vast majority of growth and demand we see is in the alternative strategies realm. In the past three years alone, we have helped advisors launch 15 alternative investment products. To date, these products have over $725 million in assets under management. Eight additional funds have been registered in 2009 and will commence operations soon.
About $1.8 trillion was in the alternative investment market as of the end of 2008 and this number will likely go up, according to Cerulli Associates. "The current market correction has acted as a catalyst, placing portfolio construction at the forefront of advisor focus," according to a Cerulli report released in April.
"The style-box approach had already lost some of its luster among advisors following the last bear market. At the end of 2008, nearly one-third of mutual fund assets were in funds that do not fit into style boxes, compared with less than one-quarter of assets in 2000," according to Cindy Zarker, director and lead author of that report, entitled, Alternative Investments in the Retail Marketplace: Evaluating Opportunities and Growth.
The severity of today's ongoing bear market means more financial advisors are rethinking the conventional wisdom. As risky as new approaches often appear at their outset, it's clear that investors also take a risk by relying on the old buy-and-hold approaches and believing that "diversification" just means owning different sizes and types of stocks and bonds.
What does this mean for advisors going forward?
It means that when we look back years from now, one of the big lessons of 2008 is that diversification has to mean more than large-cap and small-cap, value and growth, technology and consumer staples. Consider that investors who had a 401(k) with Fidelity Investments, the largest U.S. retirement plan administrator, saw their retirement savings plummet 27% last year. The average balance fell $19,000.
Even investors in "conservative" allocation mutual funds lost money. Target-date mutual funds designed for people retired or planning to retire in 2000-2010 are down over 20% in one-year returns. College savings plans lost money. This is hard-earned and saved money that investors counted on to live and fund pertinent expenses.
Of course, as risk averse as everyone seems to be these days, how can we be so sure that alternative investments will go mainstream?
One sure sign of their growing acceptance-and significance-is that Morningstar has finally given them a mutual fund category. Before, Morningstar grouped mutual funds under the traditional asset classes: U.S. stocks, international stocks, taxable bonds, municipal bonds and "balanced" funds. Today, Morningstar recognizes and rates mutual funds investing in assets with "little to no correlation" with traditional stocks and bonds. This includes currency, long-short, precious metals and bear-market mutual funds.
For advisors, this is good news. Hedge funds have typically represented the biggest portion of alternative investments. But last year, many high-net-worth investors were rightly nervous about sticking with hedge funds after two Bear Stearns hedge funds collapsed due to losses on mortgage-backed securities. By contrast, mutual funds are accessible, transparent and regulated in a way that most retail investors can be comfortable with.
For now, it is mostly the smaller players leading the way. Sierra Core Retirement Fund (SIRAX), Autopilot Managed Growth (AUTOX), Palantir Fund (PALIX) and Arrow Alternative Solutions (ASFFX) are just a few of the examples of alternative products we have helped launch and that are at the forefront of this drive to bring Harvard-like results to the average retail investor, no matter the market.