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Defining Alternative Asset Classes

by: Roger Nusbaum April 30, 2008 | about stocks: DBU / DXALF.PK / EFA / SPX / SPY    

Roger Nusbaum

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What would you include in alternative assets? What would you like to see that does not already exist in the way of accessible alternative assets?

I think getting too hung up on definitions is the wrong approach. I would say to focus more on the result a particular thing delivers and how it gets the result.

First I would say things like wine and art and even my 1971 Roberto Clemente card (I have a collection of like 20 baseball cards) are not really investments easily accessed by a lot of people. I am not saying you can't make money in these things, and I think there is an Art Fund of some sort that exists in Europe, but to the extent these are investments, that is beyond the scope of this discussion.

Dexion Absolute is a publicly traded fund of hedge funds that is listed in the UK under ticker DAB.L but is available in the US (DXALF.PK).

If you look at a two year chart compared to the S&P 500, there is plenty of zig versus SPX's zag. Maybe there is enough for you or maybe not, but there is clearly some zig. If you find some sort of long/short product, regardless of what it trades, that consistently delivers an non-correlative result, it would likely fit my definition of alternative assets.

The few that I use -- so stressing moderation -- generally deliver a non-correlative result. Obviously you can drill (or bog?) down in more detail but at some point it becomes counterproductive (subjective opinion).

If you think about all the types of products that you know of in this realm like commodity, currency, strategic, toll roads (do these count?) and I'll include hydro funds (I do not own any of these), I can tell you there are plenty more out there that you have never heard of (I seem to find a new one every few days). The chance to find and learn about these is vast. No one will likely be an expert in all of these things. Even if you can come up with a dozen different categories of what you term as alternative, it is doubtful you need more than two or three in your portfolio and even that may be too many.

If you are going to swim in this pool I would suggest being cognizant of the issue of hedging an equity portfolio with a few alternative ideas versus hedging a portfolio of alternative strategies with a few equities.

I'll finish with alternative ideas I'd like to see or see more of. For a while XShares had been on file for the AirShares EU Carbon Allowances Fund. I don't know whether this fund will ever come, but something that accesses the carbon credit market is bound to come, the growth in this market would seem to be substantial and I think the correlation to US equities would be very low.

The concept behind the Macquarie Pastoral Fund is very interesting to me (livestock and farmland down under). This particular product is not exchange traded so I am going to pass, but I believe if it is successful (it is a little over one year old, I believe) there will be similar products that do list on an exchange somewhere.

I like the idea of products tied to economic indicators. The correlation to stocks of this sort of thing is probably high, but some sort of product tied to GDP growth of a basket of emerging markets or frontier markets would be very interesting.

Since 2004 I have talked about the extent to which investment products will evolve to offer the chance for much more sophistication to do-it-yourselfers (this has always been obvious) and I think the pace of this will accelerate. Just because there might be several hundred alternative (assume vague definition) products doesn't mean you need more than two in an attempt to reduce your correlation a little.

Update: After Seeking Alpha ran this morning's post,a reader left a good question. He asked whether international utilities, specifically captured via WisdomTree International Utilities (DBU), are better for reducing correlation than a broader foreign product.

Well, the numbers are in and the reader is correct. According to PortfolioScience.com iShares EAFE (EFA) has a 0.84 correlation to the S&P 500 while DBU has 0.56 correlation. I would note that DBU, although dividend weighted hasn't actually paid much of a dividend which is frustrating. Regardless of the dividend DBU (which I own for a few clients) has done well, has outperformed both EFA and SPY and does have a low correlation.

The biggest risk, in my opinion anyway, would be if interest rates which are generally low start to go up. A rule of thumb is that rates moving up are bad for utilities as fixed income (talking further out on the curve) competes for some of the money that goes into utilities. I think higher rates further out on the curve would be a positive for equities as that might signal a return to normal but it sets up utilities to, at a minimum, lag a little.

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This article has 12 comments:

  •  
    Apr 30 12:01 PM
    I remember reading once that while international stocks generally were getting quite correlated with the US market, international utilities in particular displayed much lower correlations. There is an ETF (DBU) that puts these together. What do you think of these for diversification purposes (non-correlated assets)?
    Reply
  •  
    Apr 30 12:46 PM
    I find the 90 day correlation of DBU to SPY is 59.32% and DUB to IEF is (-39.29)% . That is ok but not low enough for significant diversication benifits.
    Reply
  •  
    Apr 30 01:13 PM
    Brand RB, I answer your question at the following link

    randomroger.blogspot.c...
    Reply
  •  
    Apr 30 01:22 PM
    i'm sorry i just realized i missed part of your question. DBU has helped to reduce correlation, clearly (BTW some clients own it), for a portfolio. However I am inclined to view it primarily as proxy for utilities as opposed to an alternative asset class, similar to what Raj said.
    Reply
  •  
    Apr 30 04:42 PM
    Would be nice to have the interval and timeframe of the correlation calculation shown. Without it, correlation coefficients are meaningless.

    Ex; it could be a correlation of 60-minute bars (interval) over the last 22 trading days (timeframe) [yes, a facetious example], it could be daily over the last year, daily over the last two years, etc.

    There's nothing to say that what was correlated over the last 22 trading days, year, or two years, has any correlation over the last 10, 15, or 20 years.

    If we're talking in general terms about blending non-correlated strategies, it helps to define our terms and get our timeframes of correlation measurement in line with the timeframes over which we execute the strategy ...
    Reply
  •  
    Apr 30 05:18 PM
    Interesting. cgi.ebay.com/ws/eBayIS...
    Reply
  •  
    May 01 01:44 PM
    I find this topic extremely interesting and useful. I propose a sharing of ideas or listing of symbols. Together we are stronger than alone. I will start:

    In my portfolio:

    ARBFX - exposure to arbitarge opportunities

    ALD & ACAS - Business development companies
    (I also watch PSEC & GLAD)

    DBV - currency exposure
    (I am going to research the new Widsometree currency funds and potentially add China and India)

    EFR & FCO: Floating rate funds
    (I also sprinkle in PSAFX)

    IGR: International Real Estate
    (I have been watching the Wisdomtree one as well)

    IRR & GGN: Gold & Natural resource exposure

    MIC & MFD: Infrastructure & international utilities

    PCL: exposure to lumber & land
    (have been watching CUT)

    RJI - overall commodity exposure

    RYMZX - futures

    The I have another category, I term excellence, or great, unique management, exaples: BRK -B, LUK, MKL, LTR, TAVFX, etc.

    Well that is a start. Hopefully, I spurred some thought. Please sure your thoughts,ideas or links. Lets build a list of alternative assets.








    Reply
  •  
    May 01 05:00 PM
    My investable "alternative"... asset classes are:

    International REITs - WPS (I have an equal allocation of domestic REITs via VNQ)

    Natural Resources - PCL, RYN, PCH (timberland), PRFE (energy), GLD and GDX (gold)

    Great Fund Managers who are not closet indexers: PRPFX - (excellent inflation hedge with high Sharpe Ratio - heavy in commodities, currencies, and small-caps) and Ken Heebner's CGMFX and CGMRX.

    TIPS. David Swensen strongly makes the case for TIPS as an asset class, which I buy into. Academic research indicates their powerful diversification effect.

    I like Granger's ideas above, though one I've already passed on. ARBFX has nearly 2% fees, low net returns and a negative Sharpe Ratio. With five year CAGR of just 5%, it's too volatile for me to hold. I want to get paid for risk. Low correlation isn't enough.

    I think a very important question we need to answer is, how much exposure is meaningful? How thin do we slice the pie? How big should our "alternative"... category (or any category) be? How big should any sub-slice within it be to be helpful in moving us toward diversified returns?
    Reply
  •  
    May 02 06:16 AM
    Here is my asset allocation model:
    Diversifed Income 30%
    Equities 30% (20 Domestic, 10% Foreign)
    Hard Assets 15%
    Alterntive/Real Return/Hedging 10%
    Cash/T-bills/TIPs 5%
    Speculative 5%
    Special Opportunites 5% or held as cash

    I then position size everything using %risk
    Reply
  •  
    May 02 09:11 AM
    great thread, guys
    Reply
  •  
    May 02 01:20 PM
    I go:
    15% US stock market - mostly index, plus some value-oriented no-load managers (FAIRX, UMBIX)
    19% Alpha-seeking (brilliant mutual fund managers who pursue non-correlated strategies)
    14% International developed market (mostly EFA, plus some WGRNX)
    5% Emerging markets (VWO)
    5% US REITs (VNQ)
    5% International REITs
    7% Natural resources/commodities
    15% US Government bonds/insured munis/money market funds (mix depends on yield curve and spread of taxable vs tax free yields)
    15% TIPS
    Reply
  •  
    Jun 21 12:03 PM
    RYFOX is an interesting mutual fund to consider. It combines commodity futures (long and short), currencies, hedging/real return and real estate all in one fund. The mix is adjusted depending on market conditions.
    Reply
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