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More money managers are turning to alternative investments to diversify their portfolios, even amid rising yields for seemingly safer bonds and guaranteed investment certificates (GICs).
More than two-thirds (69 per cent) of advisors are using alternatives – such as private equity, debt, real estate, royalties and infrastructure – to reduce exposure to public markets, according to a recent report from Cerulli Associates Inc. in Boston. The report says 66 per cent are using alternatives for “volatility dampening and downside risk protection.”
Cerulli characterized the current environment as “a Goldilocks moment for alternative investment distribution,” as rising demand coincides with an increase in the number of products on the market.
Kash Pashootan, founder and chief executive officer at First Avenue Investment Counsel Inc. in Toronto, has been adding alternatives to his portfolios in recent years as a diversification strategy alongside stocks and bonds.
“Alternatives help investors live with the overall drawdown of their portfolio in a challenging equity market because they’re not mark-to-market,” he says.
The downside with alternatives is that the assets are much less liquid, he adds, but describes it as “manageable” in a broader portfolio with more liquid assets like stocks and bonds.
While some investors may see GICs as a better option in volatile markets, Mr. Pashootan says it depends on the type of alternative investment.
He says there’s no risk asset, including alternatives, that can be compared to GICs. But alternatives have been taking capital both from equities and fixed income.
“Compared with alternative investments that are more income-focused, everything in the income category is now being judged against the higher opportunity cost of the zero-risk proposition often found with GICs that are insured,” he says.
Still, Mr. Pashootan says it’s important to distinguish the type of alternative investments. “Different types of alternative investments have different risk profiles, attributes and objectives,” he says.
For example, Mr. Pashootan says his firm has two alternative strategies – one focused on providing no income that’s illiquid and can also deliver capital appreciation upon exit; another focused on quarterly income with no real capital appreciation.
“Those serve two very different purposes in a portfolio. They’re both important, but they don’t operate the same way or have the same attributes,” he says.
Mr. Pashootan adds alternatives aren’t a “magical way” of achieving great returns without risk.
“It’s about using alternatives strategically in a manner that works from an overall portfolio approach to further diversification and reduce reliance on the stock market for portfolio growth,” he says.
Income-producing alternatives versus GICs
For Michael Schnitman, senior vice president, head of alternative investments at Mackenzie Investments in Boston, there are different types of alternatives – alternative strategies that use shorting or leverage as tools for their investment approaches; alternative assets such as real estate and commodities; and private markets including private equity, credit and infrastructure, and specialty finance.
He says income-producing alternatives, such as private credit, are different from GICs, which are akin to “parking cash.”
“GICs serve a specific purpose for people,” Mr. Schnitman says. “Advisors need to work with their clients to figure out how much to allocate to GICs, if anything.”
He warns against investors having too many GICs in their portfolio, even with rates rising.
“If inflation is running at high single digits, and GICs rates yielding lower to mid-single digits, then anyone who’s putting their money in a GIC is actually losing purchasing power,” he says.
Mr. Schnitman also argues that GIC yields can’t be compared to private equity and private infrastructure investments.
“Private equity is not a yield-focused asset class – it’s an equity-based investment. ... The investment process and goals of private equity have no relationship to GIC yields,” he says. “And private infrastructure is a total return concept. So, you have some yield with private infrastructure, but you also have appreciation.”
Alternatives don’t have to be ‘esoteric’
Robert Janson, co-CEO and chief investment officer at Westcourt Capital Corp. in Toronto, says GICs have become more attractive for investors with more medium-term cash needs, even with inflation running higher than their returns.
“It doesn’t mean everybody should run to the local bank or credit union branch and load up on GICs, but they weren’t even a consideration for a lot of people as recently as six months ago,” he says, adding that they’re unlikely to take away interest from alternatives.
“Alternatives are return drivers for diversification, for muting of volatility, while GICs are a bucket for something else,” he says. “I don’t think one will cannibalize the other by any means.”
Alternatives are also more accessible than ever with fees coming down as more products hit the market, Mr. Janson says. And the investments can be relatively straightforward in assets like self-storage space, which his firm owns, or infrastructure, such as buildings and bridges.
“We are always attempting to explain alternatives in a manner that people can wrap their head around,” he says. “It doesn’t have to be esoteric.”
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