Note: This article is courtesy of Iris.xyz
By Bill Acheson
Even for those of us who see the market as a mostly cyclical, reliable environment, the past decade or so has been quite a wake-up call.
While many portfolios have seen a recovery since 2008, most investors still get the jitters whenever the market dips. The logical response for investors and advisors alike is to seek out new investment vehicles that produce yield and help protect assets—even in the face of another bear market. But where can you find that yield? The Fed is expected to raise interest rates in 2016, but even if they do, the jump won’t be enough to significantly improve yields for most income-oriented investors.
Seeking yield is a tricky business in today’s environment, which is why more advisors than ever are exploring alternative investments. If you’ve been exploring alternatives in an effort to find some level of reliable yield for your clients, it’s important to understand the complexity of correlation—especially when considering “non-correlated” alternatives. The desire for investments that don’t fluctuate with traditional financial markets (stocks, bonds, and real estate) is understandable, but the reality isn’t always what it seems at first glance.
The interesting thing about correlation is that it tends to hide when things are good, and becomes really visible (at the very worst time) when things are bad. 2008 was an all-too-painful reminder of how this works. Anyone invested in “non-correlated alternatives” like REITs, BDCs, and energy stocks at the time were under the illusion that these investments were providing diversification in their portfolios. But when the stock market crashed, all of these vehicles began to exhibit frighteningly high correlations—and returns suffered, to say the least. The same thing happened as recently as this past December and January when correlations of “non-correlated” assets spiked. The lesson learned? Correlation can be surprisingly relative, and so-called non-correlated assets only live up to their name if you look at them at the right time.
This puts advisors in a tough position. A recent survey by WealthManagement.com of 755 advisors revealed that most advisors (43% of those surveyed) use alternatives to provide greater diversification and uncorrelated return. But what if the alternatives being used aren’t truly uncorrelated? To achieve their goals, advisors need to find a new alternative—one that has no market correlation, yet has the potential to generate significant returns.
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