When Volatility Knocks

Extraordinary times could call for extraordinary investments.

The unpredictable presidency of Donald Trump has helped return volatility to financial markets, and alternative assets may benefit. That’s the view of some asset managers, advisors and analysts who will be speaking at Financial Advisor’s 9th Annual Inside Alternatives and Asset Allocation Conference, which is scheduled to run from September 24-25 at the Wynn Las Vegas.

“I’ve never seen a president more bullish and bearish for the markets at the same time,” says Ed Yardeni, president of New York-based Yardeni Research. “There are deregulation and tax cuts, which are bullish for earnings and the market, and the economy in general. Yet, at the same time, a few weeks after the tax package was enacted, Trump’s administration started focusing on protectionism, which is something that poses a lot of challenges for individual companies.”

Until recently, investors had little reason for concern. Traditional asset classes benefited from a 30-year decline in interest rates, creating an extended bull market in bonds. Then, several years of near-zero rates and accommodative monetary policy catalyzed an extended bull market in equities.

Yardeni remains optimistic on the economy and unconcerned about recession risks. However, he also expects uncertainty and volatility to continue over the short term, which could help drive more assets into alternatives.

Liquid alternative funds enjoyed rapid growth in the years following the global financial crisis, but slowed as assets flowed toward inexpensive passive products through a low volatility bull market. According to Wilshire Associates, the liquid alternatives universe gained $9 billion in assets during the first quarter of 2018, growing to encompass 494 funds with $333 billion in assets.

Advisors who had few reasons to incorporate alternatives in recent years may be changing their tune—but not necessarily on liquid alternatives. More investors have become comfortable investing in real assets, private equity and alternative debt instruments, says Paul Pagnato, founder and CEO of PagnatoKarp, a $3.5 billion RIA based in Reston, Va.

“I think it’s timely to talk about alternatives,” Pagnato says. “There’s not a lot of people who you could talk to right now who would say that stocks are inexpensive or that they’re not overvalued. That’s not to say that they can’t go higher; bull markets always last longer than they should. But we do know from historical measurements that valuations are high.”

Pagnato says that his clients on average have between 25% and 35% of their portfolios in alternatives, most often using them to boost cash-flow generation. For example, Pagnato uses reinsurance to try to generate an 8% annual total return, with annual cash flow of 6%.