Avoiding Mea Culpas With Alternative Assets

The Wall Street Journal recently published an article exploring the merits of alternative assets. It included mea culpas from investment managers who had invested too much in alternative assets and a look at several segments within that category.

There are ways the managers could have avoided those regrets. Let me explain.

I've been writing about investing in alternative-asset investing for several years, with the belief that a moderate -- let me stress the word "moderate" -- allocation can reduce volatility. I have found long-short mutual funds, exchange-traded products that track carbon credits, Norwegian fishery stocks, Malaysian plantation stocks and more. Learn about as many of them as you can, but invest selectively and in small increments.

When you start to conduct your own research, you will find various white papers telling you to put 20% in commodities or 20% in real estate investment trusts (REITs). Soon you end up with a portfolio of alternative assets hedged with just a little bit of equity exposure. In the WSJ article, there were quotes from asset managers with 15% to 20% in investments such as commodities, and there was regret. Commodities have had their own bear market, starting about eight months after the bear market in equities.

The first asset class profiled in the article is real estate, via REITs. I have given up on REITs as a diversifier, having sold the one REIT I owned for clients in December 2007. The correlation to financial stocks was very high and, while all correlations generally increased among many asset classes in this bear market, the link between REITs and financial stocks rose very early in the bear market. The Journal article theorizes that REITs have lost their appeal for diversification for being over-owned. Maybe that is correct but, either way, I'm inclined to think of REITs as a subsector of financials and not a portfolio diversifier.