Making money through investments hasn’t been easy lately. Real estate is down. The stock market’s down. Bonds aren’t paying much beyond what you’d get by storing the cash in your basement safe.
As a result, more investors are turning to strategies not usually seen in the mainstream markets, from mutual funds that bet on the future prices of commodities to funds that trade on the value of companies that might merge—a technique that insiders call merger arbitrage.
The popularity of these “alternative investments” has skyrocketed in recent years; Morningstar reports that $10.5 billion flowed into such funds in 2009, more than five times the amount in 2005.
They’re not just for the wealthy anymore. “Ten years ago, you needed a million dollars to get into this. Today these strategies are available to the average investor,” says Barry Glassman of Glassman Wealth Services in McLean. Many new funds require minimum investments of only $1,000.
After experiencing steep losses in 2008 and 2009, many investors sought options beyond cash, stocks, and bonds, says Glassman.
“Prior to the Great Recession, people thought diversification meant buying foreign stocks, smaller companies, and bonds,” he says. “They learned the hard way that that didn’t diversify their portfolio.”
While many financial advisers recommend sticking with those traditional diversification strategies, others suggest turning to vehicles that don’t move in sync with the stock market. Alternative investments fit that bill because they take both “long” and “short” positions, meaning they bet on prices going up as well as down. Hedge funds and private-equity funds have long met this demand for the super-wealthy.
Over the past several years, Rockville-based Rydex SGI launched a series of alternative funds, including its flagship Managed Futures Strategy fund, which tries to anticipate fluctuations in the prices of commodities and global financial futures, such as currencies.
“These funds won’t necessarily react to equity or interest-rate movements,” says Marc Zeitoun, a managing director at Rydex SGI. “They have their own drumbeat.”
“I can’t think of one portfolio that wouldn’t benefit from alternative investments,” because of their diversification benefits, says Nadia Papagiannis, alternative-investment strategist for Morningstar. According to her analysis, the average long/short mutual fund lost about 25 percent between early October 2007 and early March 2009. The S&P 500 lost about 55 percent over the same period. Investors also want to compare the funds’ expenses—long/short funds tend to carry slightly higher expense ratios than traditional funds, though the ratios vary.
For investors interested in venturing beyond the traditional path, what follows is an overview of some of the most popular options.
But not everyone is a fan. Nathan Gendelman, director of investments at the Family Firm, a fee-only financial-planning firm in Bethesda, steers his clients away from alternative investments, largely because he doubts many will produce positive returns over the long term. With managed futures, for example, he says you’re neither loaning money to a productive company nor investing in one. Instead, you’re using a formula to buy something when the price goes up and to sell when the price goes down.
“There’s nothing in these that’s really an investment,” he says. “What’s the difference between that and spinning a roulette wheel?”
Gendelman also notes that because many alternative investment methods are so new, they lack a sufficient track record.
Aimee Daniels, regional president for the Mid-Atlantic at HSBC, says alternative investments are still unusual for anyone but the wealthiest clients.
“They tend to be technical enough that you need someone to walk you through it,” she says. “How does it work? Does it lock up your money? How does it match your overall goals?”
Instead of exploring such uncharted territory, many of Daniels’s clients are taking their money out of the stock market and using the cash to pay off mortgages or refinance to take advantage of lower interest rates.
“We’ve seen a lot of people saying, ‘I don’t want to have debt right now,’ ” she says.