Alternative Investments – Alternative Ways to Lose Money?

Alternative investments consist of any asset that doesn’t fit an existing, traditional asset class such as stocks, bonds, and cash. Gold, commodities, hedge funds and private equity are commonly lumped in as “alternative assets.” And due to the historically low correlation with stock markets and relative outperformance of some assets that fit in the alternative category, the entire category may be viewed favorably by investors and advisors. But the category also has a bunch of “crap” in it.

Know What You Own

A common mental shortcut, and well-known behavioral bias, is the representativeness bias. This is when we take one situation or outcome and apply it (incorrectly) to another situation that seems similar. Investors and advisors may, unconsciously, conclude that anything with the label “alternative investment” is good because we have examples of “alternative” investments performing very well historically.

We may not pause to reflect on what we are buying and potential outcomes because the mental shortcut is, “if it’s an alternative asset, it is good.” Slap the term “liquid” in front of it, and it becomes even more attractive. Investors and advisors are attracted to non-correlation, outperformance, and liquidity. “Liquid Alts” becomes a trifecta of perceived benefits that silences our skeptical brain.

The Rush to Liquid Alts Has Begun

According to Morningstar Direct, investors have poured $21 billion into liquid alts since the beginning of the year (through May). Investors are dissatisfied from declining stock and bond prices and seeking better solutions. Investors may not realize that liquid alts contain complex strategies, higher fees, and historically pretty low returns.

The Wall Street Journal warned of liquid alts in 2015 during the first boom. It fizzled out years later due to underperformance while stock and bond markets outperformed. But they are in vogue again – as investors continue their never-ending practice of performance chasing.

Liquid Alts’ Poor Track Record

The track record for liquid alts is lacking. The only promise it delivered on was its high fees. And in some cases, funds that were marketed as safe investments blew up. Investor beware!

It is beyond the scope of this blog post to make an in-depth analysis of all liquid alt investments. But we can look at two highly-touted funds to see how they have done over the years. Putnam’s Multi-Asset Absolute Return Fund and Invesco’s Balanced-Risk Allocation demonstrate significant underperformance during good markets and the inability to protect the downside during bad markets. There are many other funds like this, some of which have since closed or merged with others due to the awful performance.

UPDATE: Literally within an hour of posting this on 6/30/22, I got an email from Putnam that said,

“Putnam has recommended, and the fund’s Board of Trustees has approved, a merger of Putnam Multi-Asset Absolute Return Fund into Putnam Multi-Asset Income Fund.”

But that isn’t the worst. Perhaps one of the most egregious examples is the LJM Preservation and Growth Fund. Just the name of the fund is attractive. You mean we get both growth and preservation in one fund? The fund stated it would help investors “make volatility your asset” and that it would “harness volatility.” Instead, in a week of heightened volatility, the entire fund blew up. Beware the cunningness of investment marketing! And Investor Beware.


© 2022 The Behavioral Finance Network