If retirement portfolios were recipes, the most common ingredients would be annuities, bonds, cash and stocks. Add some real estate, most likely in the form of home equity, and you’ve got a financially diversified plate.
But is that approach truly diversified? Frank Muller, executive vice president and head of distribution for investment management firm Behringer (http://www.behringerinvestments.com) in Addison, Texas, disagrees. Muller makes the case that retirees’ portfolios should include an allocation to alternative investments; otherwise they are excessively constraining their investment options.
He defines alternatives in terms of what they’re not. Traditional investments are long-only stocks, bonds and cash. Assets outside those holdings can qualify as alternative investments, he says: “Anything that is one-dimensional investing, buying a stock, bond or cash, long-only would be traditional. I would argue that anything that is beyond that, whether it’s bi-directional, long-short, utilizes leverage or uses private equity or private debt strategies tends to be ‘alternative.’”
The Case for Alternatives
Muller believes that the demise of traditional defined benefit pension plans is a key reason retirees need alternatives. The majority of retirees manage their retirement incomes themselves, he says. They make investment allocation- and distribution decisions, effectively serving as their own defined benefit plan administrators. However, they—and often their advisors—lack an understanding of and experience with the full range of investments, including alternatives, which institutional-level administrators can access.
He conceptualizes a two-by-two investment grid to illustrate the problem. The horizontal boxes represent public and private; the vertical boxes represent debt and equity. Most individual investors limit themselves to the public boxes, he says, and consequently overlook opportunities. “When you constrain the investible universe only to public equity and public debt, therefore what you’re saying from an asset allocation perspective is that private equity and private debt don’t exist, that they have no material impact in the world’s financial ecosystem,” he says. “Yet, we know intuitively that that’s actually not true.”
The grid takes on more dimensions with the addition of directional investments—short and long/short strategies—plus the use of leverage.