Alternative perceptions vs. reality

• abnormalreturns
• January 12th, 2012

Michael McMillan writing at the Enterprising Investor blog* in reviewing a survey of the use of alternative investments by advisors writes:

Does this mean that investment advisers are recommending alternative investments to clients that they themselves don’t fully understand?  Unfortunately, I think the answer in many cases is yes.

One could argue that if they truly did understand alternatives they would not be recommending them to their clients.  Two recent examples spring to mind.

A recent book by Simon Lack entitled The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True is calling into question the viability of hedge funds as an investment:  not for the hedge fund managers themselves who seem to keep the majority of the funds’ gains but rather for the investors themselves.  Jonathan Davis writing at FT in reviewing the book writes:

Once you make adjustments for survivorship bias, fund of funds fees and so on, it is probable, he [Lack] suggests, that hedge fund managers have kept all the money made, and investors have in aggregate received nothing. Skilful investors such as Yale’s David Swensen have shown it is possible to make money from picking hedge funds carefully. Mr Lack shows in his book how that can be done. But for every long-term success story, there are more that have ended less well, highlighting the gap between perception and reality.

Another smaller “asset class” that has been touted as an alternative has been art.  This is not anything new, in fact one of our first blog posts was a skeptical take on the topic.  Felix Salmon at Reuters is tired of the financial media swallowing the story that art is somehow in any way an investable asset class.  He writes:

I’m all in favor of buying art and wine, but they’re not investments. There’s never any shortage of wine shills and art shills who will talk about them as asset classes when they go up in value. All those people should be ignored. And there should be an absolute ban on talk of how the art market “returned 11 percent to investors” and the like. We should be getting smarter about this stuff — and, in fact, the art and wine press is quite good on such matters. It’s just the financial press which perennially falls down.

Asset classes are by definition investable.  Simply calling something an asset class does not make it so.  In the rush to generate non-correlated returns investors have bought into the case that alternative “asset classes” are the way to go.  Unfortunately along they way investors failed to reflect on who is actually keeping those returns.  All the while beta became increasingly cheap and commoditized.  There are no guarantees when it comes to the return to beta.  The last decade is a prime example of that.  However in the pursuit of alpha we need to be especially careful so that those who take the risk also reap some of the returns.

*via @jasonzweigwsj

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