By Jason Policastro, as published in the Baltimore Business Journal
British explorer Sir Ernest Shackleton once said “A man must shape himself to a new mark directly [after] the old one goes to ground.”
While the investment landscape doesn’t resemble the fractured Antarctic ice that trapped Shackleton and his crew, investors would do well to heed his advice about being open to change. Why? Due to a confluence of market conditions, the traditional 60/40 portfolio (60% equities and 40% bonds) that has rewarded investors in the past may not be enough in the years ahead.
Changing market conditions
The run-up in stocks over the past few years has lifted equity valuations to record heights. Complications including slowing economic growth, the unpredictability of public health, and the impact of higher inflation mean that equities may not have much room to run. In a December article, the Wall Street Journal said that “forward-looking nominal annual returns for U.S. equities over the next 10 years are likely to be between 2% and 4%, with inflation predicted to come in at 1.5% to 2.5%.”
Meanwhile, fixed income is facing its own challenges. In a rising interest rate environment like the one we’re entering this year, bond prices drop, leaving bondholders with negative returns. Fixed-income investors with longer time horizons can benefit from reinvesting their coupon payments at higher rates, but they’re still trying to outrun short-term losses.
Consider the alternatives
The growth of alternative investments shows that more and more investors are looking beyond the 60/40 portfolio. Depending upon your needs, these options can provide income, return, and diversification, since they do not move at the same time or in the same direction as the equity and fixed income markets.
Many investors don’t know enough about alternative investments to confidently add them to their portfolios, and often they are only available to institutional investors. The term “alternative” in investing covers a lot of ground, and its meaning has changed over time. The alternative investments of yesterday, including REITs, high-yield bonds and emerging markets, are considered mainstream today. Today, the term is used to refer to investments including private equity, real estate, private credit, real assets (think timberland, private farmland, and private infrastructure), and more.
Upside/downside
Not every alternative asset functions in the same way or has the same result for investors. Some, like private equity investments, are traditionally designed to provide return over the long term. Others are more oriented toward providing current income. And many offer the prospect of both, including private real estate.
Real assets have a tangible, physical presence, like the farm you drive by on your way to work or the timber forest behind it. Their performance isn’t reliant upon the equity or fixed income markets, and the benefits they can offer are considerable. In his new book “The Allocator’s Edge”, author Phil Huber, CFA, CFP says that real assets are “a means to build a complete allocation to incomeproducing, tangible assets with built-in inflation sensitivity and meaningful risk-reward characteristics.”
Many alternatives look particularly attractive against the current backdrop of high inflation. That’s because the revenue streams for real estate and infrastructure are linked to leases that generally keep pace with inflation. According to a 2021 BlackRock study, real estate and infrastructure have historically outperformed in an inflationary environment.
As is true with any asset class, there are considerations to keep in mind as you invest in alternatives. Often they have limited liquidity windows, and there can be additional tax responsibilities, like filling out an annual K-1 form. It’s a good idea to consult with your financial adviser when considering adding alternatives to your portfolio.
Jason Policastro is a private wealth advisor at Cornerstone Advisory and the chair of the Communications Committee at the Financial Planning Association of Maryland. He can be reached at jason@cornerstoneadvisory.com.
As always, if you have any questions or would like to have a conversation, please reach out to us or your portfolio manager.
The Cornerstone Team
Disclosure: Cornerstone Advisory, LLC, is registered as an investment adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals, and economic conditions may materially alter the performance of your portfolio.