Traditional portfolio construction using just long-only stocks and bonds is yesterday's story and no longer enough to generate real diversification and sustained performance, said Ricardo Cortez, senior
portfolio management specialist at Broadmark Asset Management LLC.
“Generally speaking, stocks over the next several years will be pretty sluggish and you won't be able to get 7% to 10% annual returns just using stocks and bonds,” he said. “You just can't get there from here with traditional strategies.”
Speaking at the Investment Management Consultants Association annual conference in Las Vegas, Mr. Cortez encouraged financial advisers to start embracing the idea of alternative investment strategies.
“The investment management industry is changing and in the long run alternatives will need to blend with traditional assets,” he said. “It is all changing because of the market performance over the last 10 years, because of an increased emphasis on risk management and because clients are asking us to be more tactical.”
As part of his case for being more tactical, Mr. Cortez illustrated that dating back to 1871 there have been five periods during which the S&P Composite and its precursor indices saw multi-year declines similar to or worse than those of the past decade.
Between 1968 and 1982, for example, the S&P index fell by 63%, after which began a 20-year bull market run.
“This kind of thing has happened before, and it's not new, but we do need new ways to deal with it,” he said.
Along those lines he cited the Harvard University endowment, which has a 52% allocation to alternative investments. By contrast, he said most individual investors have about 5% allocated to alternatives.
“I'm not suggesting everyone should do what Harvard does, but to be somewhere in the middle might be appropriate,” he said.
One mistake a lot of advisers make, he said, is in using the popular core-satellite approach they will allocate the largest portion in the core to broad market indexes that only benefit during up markets.
“Simple core and satellite is not the way to look at the markets today,” he said. “I suggest adding some non-correlated risk management to the core.”
Reducing exposure to market downturns, he said, can lead to easier and faster recoveries from losses.
In a break-even analysis of the S&P 500 Index between 1960 and 2010, Mr. Cortez illustrated that by avoiding just 60% of the downside of the market through hedging or tactical investing an investor only needed 55% of the performance of the S&P to keep pace with the index.
In terms of access to alternative strategies, he pointed out that the financial services industry is moving toward the retail market with registered mutual funds that offer a variety of non-correlated strategies.
“Some of the alternative mutual funds will not make the transition well,” he said. “But the industry is taking many of the risk-managed strategies and making them available in registered products.”
