Morningstar Advisor - June/July 2013 - (Page 40)

Spotlight Using Alternatives in Practice By Jerry Kerns Advisors and clients need to understand what they’re buying and the role a strategy has in a portfolio. The number of liquid alternatives offerings has skyrocketed since the 2008 financial crisis. Not satisfied with the performance of their traditional stock and bond portfolios, many advisors and investors have sought out the sophisticated strategies that hedge funds and institutional investors have been using for decades. Mutual fund and exchange-tradedfund firms quickly answered the call. The fund industry has launched hundreds of alternative offerings of varying strategies and asset classes over the past five years. To get a practical view of this burgeoning segment of the industry, we interviewed three professionals who have many years of experience investing in alternatives for clients. Bradley Alford founded Alpha Capital Management in 2006, a registered investment advisor based in Atlanta. He is the portfolio manager of Alpha Opportunistic Growth ACOPX and Alpha Defensive Growth ACDEX. Richard Raby is a portfolio manager for Creative Financial Group, also based in Atlanta. The firm provides financial planning and investment advisory services for high-net-worth clients. Richard Bregman is the founder and CEO of MJB Asset Management, a RIA firm based in New York City. The three will appear together June 13 at the 2013 Morningstar Investment Conference in Chicago. 40 Morningstar Advisor June/July 2013 Jerry Kerns: What is your definition of an alternative investment? Bradley Alford: The term alternative invest- ment is used to describe both asset classes and investment strategies. Alternative asset classes are those other than the three traditional asset classes, which are stocks, bonds, and cash. Examples of alternative asset classes are private equity, real assets, and commodities. Alternative strategies are those that use management techniques other than long-only, such as leverage and short selling. The term hedge fund is generally used to describe the vast array of alternative investment strategies. It’s worth highlighting that alternative investment strategies are implemented using traditional asset classes, as well as alternative asset classes. Richard Raby: An alternative investment is any investment outside the standard, long-only investments in equities and fixed income. This would include precious metals, futures, short positions, options, and asset-allocation strategies that can use those same vehicles. there are three categories of investments: equity (ownership), debt (lending), and insurance (short sales and derivatives). So-called long positions in equity and debt are typically referred to as traditional investments; alternatives incorporate that third category— insurance as a hedge against security, industry, and systemic risks. Alternatives by themselves are not an asset class. For example, from this perspective, a long-only commodities fund is a traditional equity portfolio in that you own a basket of stocks, metals, or contracts. Long-only REIT funds are traditional equity funds because you own positions in REITs. An emerging-markets bond fund is a traditional fixed-income portfolio because you are lending to emerging country governments or corporations. By contrast, a long/short commodities fund, or a long/short REIT fund, or a long/short emerging-markets bond fund is an alternative strategy, as the funds contain traditional positions in stocks and bonds but also contain short positions as insurance. Adding that third category—insurance— typically will reduce correlations with traditional strategies and reduce volatility relative to traditional strategies. Richard Bregman: Alternatives are not investments per se, but rather are strategies that incorporate some element of hedging, whether through individual short sales or by use of derivatives, such as options, futures, swaps, etc. From this perspective, Kerns: What role should alternative investments play in a portfolio? Alford: Alternative investments are intended to generate returns that are far less dependent

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2013

Morningstar Advisor - June/July 2013
Letter From the Editor
Not Your Values
How Do You Use Alternatives for Clients?
Working to Build a Niche
How to Put Buffett’s Investing Philosophy into Practice
Sophisticated Strategies for the Masses
Investments á la Carte
Investment Briefs
The Percentile Trap
Defense Firms Will Stay Aloft
Beware the Lure of Diversification
Using Alternatives in Practice
Managed Futures and Cash Rates
The World Is Getting Grayer
Waiting to Pull Up Anchor
The Price of Managing Volatility
Let’s Get Back to Basics
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Mutual Fund Urban Myths

Morningstar Advisor - June/July 2013