For years, alternative investments have been a way for investors to enhance their returns while reducing the risk and volatility in their overall portfolio. Until recently, most alternative investments have been out-of-reach for the average investor primarily because they are not publicly traded, typically require large investments of $250,000 or more, and sometimes require keeping that investment illiquid for long periods of time. Today, some of this has changed, and average investors have more opportunities in alternative investments than ever before.
Over the past 10 years, Wall Street has taken some steps to cater to the average investor's interest in alternative investing, particularly with regard to real estate, commodities/energy, and market neutral/absolute return hedge funds. There are a number of mutual funds, exchange traded funds (ETFs) and more recently, exchange traded notes (ETNs) that deal specifically with these asset classes with relatively low initial investment requirements.In real estate, there are a large number of U.S. REIT mutual funds and ETFs available with minimums as low as $2,500. Some to consider include the mutual fund, Vanguard REIT Index Fund (VGSIX) and the ETF, Barclays iShare Dow Jones U.S. Real Estate Index Fund (IYR). While U.S. REIT funds have been available for quite some time, there are now products available that offer exposure to international real estate. Some examples of internationally focused ETFs include the Barclays iShare, the S&P Developed Ex-U.S. Property Index Fund (WPS) and the SPDR Dow Jones International Real Estate Fund (RWX). For investors interested in researching the entire universe of available product, The Fund Screener and ETF Screener functionality on the Morningstar website can help provide useful information to assist in the investor's fund selection process.
- For U.S. REIT mutual funds, search Fund Screener for the Domestic Stock category in the Fund Group, and then select Real Estate in the Morningstar Category. For international REIT mutual funds, search for the International Stock category in the Fund Group, and then select Global Real Estate in the Morningstar Category.
- For U.S. REIT ETFs, search ETF Screener for the Specialty Stock category in the Fund Group, and then select Real Estate in the Morningstar Category. For international REIT ETFs, search for the International Stock category in the Fund Group, and then select Global Real Estate in the Morningstar Category.
With regard to energy and commodities investing, there are a number of mutual funds and ETFs available. Because ETFs trade like stocks, you can buy as little or as much as you want in your brokerage account. For example, an investor can now buy an ETF that tracks the price of oil.
Another relatively recent investment vehicle to invest with commodities are exchange traded notes (ETNs), which can provide investors with exposure to broad based commodities indices such as the S&P GSCITM Total Return Index and the Dow Jones-AIG Commodity Index Total Return. ETNs can also provide exposure to individual commodities such as platinum, copper, coffee, cotton or sugar. These notes are basically IOUs from the companies offering them, so there is an additional risk of those companies going out-of-business for investors to consider. But if you are prepared to assume this risk, exchange traded notes are a low cost way to invest in either diversified commodity baskets or specific commodities. Some commodity-focused vehicles to consider include the ETF, Barclays iShare GSCI Commodity-Indexed Trust (GSG) and the ETN, Barclays iPath® Dow Jones-AIG Commodity Index Total Return (DJP). For energy, some examples include the ETN, Barclays iPath Dow Jones-AIG Energy Total Return Sub-Index (JJE) and the ETF, Deutsche Bank's PowerShares DB Energy Fund (DBE). Here are some tips for doing some additional research on commodities and energy investments on the Morningstar website:
- For energy/commodities mutual funds, search Fund Screener for the Domestic Stock category in the Fund Group, and then select Natural Resources in the Morningstar Category.
- For energy/commodities ETFs and ETNs, search ETF Screener for the Specialty Stock category in the Fund Group, and then select Natural Resources in the Morningstar Category.
Most recently, within the last three or four years, market neutral/absolute return hedge funds have become available in a mutual fund structure. These vehicles are designed to offset stock market volatility by attempting to give investors a non-correlated return stream, and by attempting to generate positive returns in all market environments, regardless of how the stock market is performing. The two products our firm uses in this asset class performed relatively well in what was a difficult 2008. Their performance ranged from a gain of 8.5 percent to a loss of 13.5 percent, which served to offset the 37 percent loss for the S&P 500 in 2008.
These funds, which are regulated by the Securities and Exchange Commission (SEC), have minimum investments of around $2,500. These ‘hedge fund' mutual funds do not have the same flexibility in their trading strategies as private hedge funds. Private hedge funds are not regulated by the SEC, and typically require initial investments of $250,000 to $1 million. But these mutual funds, such as the Rydex Managed Futures Strategy Fund (RYMFX), for example, may still be a good option for average investors looking to diversify their portfolios and reduce portfolio volatility. For more details, go back to the Morningstar website and search the following:
- For ‘market neutral/absolute return hedge fund' mutual funds, search Fund Screener for the Alternative category in the Fund Group, and then select Long-Short in the Morningstar Category.
- For ‘market neutral/absolute return hedge fund' ETFs and ETNs, search ETF Screener for the Alternative category in the Fund Group, and then select Long-Short in the Morningstar Category.
Generally, only venture capital and private equity investments remain out-of-reach for the average investor because of the large amount of capital involved and the long, undetermined time horizon. This exclusivity and long-term perspective is the key to private equity's success. Private equity investing requires the stable funding and patience to allow the company they have invested in time to grow and/or turn around with the private equity investor group's assistance. That stable funding and patience normally does not exist in the publicly traded market.
Still, for the sophisticated investor, opportunities in alternative investments abound. As with any investment, just be sure to appropriately weigh the risks as well as rewards, and be sure to thoroughly research a fund's past performance, fees, and management team before deciding to invest.
Mark Willoughby, CFA, CFP®, ACA, is a Principal and Wealth Manager with Modera Wealth Management in Old Tappan. Modera Wealth Management is a nationally recognized, fee-only wealth management firm serving the wealth management needs of clients across the country.