Morningstar Advisor - December/January 2010 - 32
Spotlight Alternative Investments Go Mainstream By Nadia Papagiannis They reduce risk, are easy to access, and are becoming cheaper. There’s probably a place for alternatives in your clients’ portfolios. The latest catchphrase in asset management is “alternative investments.” Ten years ago, the term floated among only the wealthiest investors, who put their money in hedge funds and private equity funds. Most average investors hadn’t even heard of such investments. For those who knew of them and wanted in, entry was strictly limited. Plus, the whole idea of alternative investments seemed a little suspicious. But today, some of the largest asset-management firms—Vanguard, PIMCO, iShares, and Franklin Templeton, to name a few— have opened the door to a host of alternative investments for mainstream investors. Companies such as Putnam, with its lineup of new “absolute return” funds, have launched aggressive advertising campaigns to promote their alternative funds. The average investor can no longer ignore alternatives, and neither can his advisor. So, what should advisors make of these funds? Are they simply overpriced gimmicks, or do they deserve a serious look? Here’s an overview of what alternative investments are, who’s buying them, and how the right ones can have a place in many investors’ portfolios. Alternatives Defined a typical stock or bond. In terms of asset class, an alternative investment could mean real estate, commodities (and stocks with exposure to them), currencies, Treasury Inflation-Protected Securities, convertible bonds, high-yield bonds, and emerging-markets stocks and bonds. “Alternative” also has been used to describe 130/30, absolute-return, long-short, marketneutral, short-selling, bear-market, and leveraged-long or -short trading strategies. Morningstar analysts say that alternative investments should attempt to accomplish two things: provide a positive risk-adjusted return over time (as any investment should) and have a low correlation to traditional stock and bond investments. The idea of an alternative investment is to diversify a traditional one—to reduce the risk while improving the overall risk-adjusted return. This diversification is achieved by using a different trading strategy (shorting and hedging) and different instruments (commodity futures and currencies) that provide a different risk/return profile than traditional investments. By this definition, many investments commonly labeled as “alternative” are, in fact, not. For example, 130/30 strategies aim to be 100% net long traditional exposure. That results in a near 100% correlation to investors’ existing stock and bond investments. Real estate investment trusts are another example. REITs are highly correlated to the overall stock market, because investors in REITs take equity stakes in an operating company. Furthermore, REITs are already included in the S&P 500, so a separate stake in REITs will not change a traditional portfolio’s risk/return profile. Similarly, stocks with commodities exposure act more like stocks, rather than the underlying commodities, and as borders open and trade increases, emerging-markets stocks are becoming more closely tied to the equity markets in developed economies. In contrast, true alternative investments— those that have a low correlation to a traditional stock/bond portfolio—will reduce or negate the losses in a portfolio. These include: Hedged Equity Today, people use the term “alternative investment” to mean almost anything that’s not Hedge-equity strategies invest in traditional stocks, but they hedge out some of the overall market risk by shorting other stocks, index ETFs, and index futures and by buying puts and writing call options (on individual stocks or indexes). The result is an investment that provides much of the upside but less of the downside of the stock market. The standard long-short or buy-write strategies fit in this category. A few hedged fixed-income mutual funds exist as well, but this strategy is difficult to carry out in a mutual fund or ETF format. 32 Morningstar Advisor December/January 2010
Morningstar Advisor - December/January 2010
Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2010
Morningstar Advisor - December/January 2010
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
How Big a Role Do Alternative Investments Play in Your Practice?
In for the Long Term: Dana Emery
It's All About the Plan
Investment Briefs
A More Powerful Bankruptcy Prediction Model
This Time It’s Personal
Alternative Investments Go Mainstream
After Meltdown, More Advisors Turn to Alternatives
Where to Find Low Correlation
Commodities Are a Rock in a Hard Place
How Alternatives Protect Portfolios
Shipshape
Slow Scrutiny
Four Picks for the Present
Are Utilities’ Dividends Worth the Worry?
High-Confidence Stock Picks
Long-Short Funds That Pass a Simple Stress Test
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
VA Sales See Some Recovery
New at Morningstar
I Read the News Today, Oh Boy
Morningstar Advisor - December/January 2010 - Morningstar Advisor - December/January 2010
Morningstar Advisor - December/January 2010 - Cover2
Morningstar Advisor - December/January 2010 - Contents
Morningstar Advisor - December/January 2010 - 2
Morningstar Advisor - December/January 2010 - 3
Morningstar Advisor - December/January 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - December/January 2010 - 5
Morningstar Advisor - December/January 2010 - 6
Morningstar Advisor - December/January 2010 - Letter from the Editor
Morningstar Advisor - December/January 2010 - Contributors
Morningstar Advisor - December/January 2010 - 9
Morningstar Advisor - December/January 2010 - How Big a Role Do Alternative Investments Play in Your Practice?
Morningstar Advisor - December/January 2010 - 11
Morningstar Advisor - December/January 2010 - In for the Long Term: Dana Emery
Morningstar Advisor - December/January 2010 - 13
Morningstar Advisor - December/January 2010 - It's All About the Plan
Morningstar Advisor - December/January 2010 - 15
Morningstar Advisor - December/January 2010 - Investment Briefs
Morningstar Advisor - December/January 2010 - 17
Morningstar Advisor - December/January 2010 - 18
Morningstar Advisor - December/January 2010 - 19
Morningstar Advisor - December/January 2010 - A More Powerful Bankruptcy Prediction Model
Morningstar Advisor - December/January 2010 - 21
Morningstar Advisor - December/January 2010 - 22
Morningstar Advisor - December/January 2010 - 23
Morningstar Advisor - December/January 2010 - 24
Morningstar Advisor - December/January 2010 - 25
Morningstar Advisor - December/January 2010 - This Time It’s Personal
Morningstar Advisor - December/January 2010 - 27
Morningstar Advisor - December/January 2010 - 28
Morningstar Advisor - December/January 2010 - 29
Morningstar Advisor - December/January 2010 - 30
Morningstar Advisor - December/January 2010 - 31
Morningstar Advisor - December/January 2010 - Alternative Investments Go Mainstream
Morningstar Advisor - December/January 2010 - 33
Morningstar Advisor - December/January 2010 - 34
Morningstar Advisor - December/January 2010 - 35
Morningstar Advisor - December/January 2010 - After Meltdown, More Advisors Turn to Alternatives
Morningstar Advisor - December/January 2010 - 37
Morningstar Advisor - December/January 2010 - Where to Find Low Correlation
Morningstar Advisor - December/January 2010 - 39
Morningstar Advisor - December/January 2010 - Commodities Are a Rock in a Hard Place
Morningstar Advisor - December/January 2010 - 41
Morningstar Advisor - December/January 2010 - How Alternatives Protect Portfolios
Morningstar Advisor - December/January 2010 - 43
Morningstar Advisor - December/January 2010 - 44
Morningstar Advisor - December/January 2010 - 45
Morningstar Advisor - December/January 2010 - 46
Morningstar Advisor - December/January 2010 - 47
Morningstar Advisor - December/January 2010 - Shipshape
Morningstar Advisor - December/January 2010 - 49
Morningstar Advisor - December/January 2010 - 50
Morningstar Advisor - December/January 2010 - 51
Morningstar Advisor - December/January 2010 - Slow Scrutiny
Morningstar Advisor - December/January 2010 - 53
Morningstar Advisor - December/January 2010 - 54
Morningstar Advisor - December/January 2010 - 55
Morningstar Advisor - December/January 2010 - Four Picks for the Present
Morningstar Advisor - December/January 2010 - 57
Morningstar Advisor - December/January 2010 - 58
Morningstar Advisor - December/January 2010 - Are Utilities’ Dividends Worth the Worry?
Morningstar Advisor - December/January 2010 - 60
Morningstar Advisor - December/January 2010 - 61
Morningstar Advisor - December/January 2010 - High-Confidence Stock Picks
Morningstar Advisor - December/January 2010 - 63
Morningstar Advisor - December/January 2010 - Long-Short Funds That Pass a Simple Stress Test
Morningstar Advisor - December/January 2010 - 65
Morningstar Advisor - December/January 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - December/January 2010 - 67
Morningstar Advisor - December/January 2010 - 68
Morningstar Advisor - December/January 2010 - 69
Morningstar Advisor - December/January 2010 - 50 Most Popular Equity ETFs
Morningstar Advisor - December/January 2010 - 71
Morningstar Advisor - December/January 2010 - 72
Morningstar Advisor - December/January 2010 - Undervalued Stocks
Morningstar Advisor - December/January 2010 - 74
Morningstar Advisor - December/January 2010 - 75
Morningstar Advisor - December/January 2010 - VA Sales See Some Recovery
Morningstar Advisor - December/January 2010 - 77
Morningstar Advisor - December/January 2010 - 78
Morningstar Advisor - December/January 2010 - New at Morningstar
Morningstar Advisor - December/January 2010 - I Read the News Today, Oh Boy
Morningstar Advisor - December/January 2010 - Cover3
Morningstar Advisor - December/January 2010 - Cover4
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