Morningstar Advisor - June/July 2013 - (Page 7)

Letter From the Editor Diversify Me Jerry Kerns Follow Jerry on Twitter @ jerrykerns Many investors are buying into the alternatives story—that in today’s market they need more than traditional stocks and bonds in their portfolios to guard against downside risk—but are they receiving the diversification benefits they think they’re getting? Morningstar’s Michael Coop thinks investors often are not. In his Spotlight article, “Beware the Lure of Diversification,” Page 36, Coop, the head of alternative investments with Ibbotson Associates Australia, says that investors often overpay for alternative assets that behave too much like equities and fixed income. Just because an investment is being marketed by the industry as alternative doesn’t mean it will magically diversify a stocks-and-bonds portfolio. Coop focuses on two elements: the drivers of returns and valuation. He says that investors first need to take the time to understand the market elements and conditions that affect the returns of stock and bonds and then find alternative investments that behave differently. After all, the true test of an alternative investment is whether adding it to a traditional portfolio improves the portfolio’s risk-adjusted returns, not hurts returns. In his article, Coop runs a study to find the types of alternatives that are truly the best diversifiers. But then, Coop says, investors need to be mindful of valuation and the amount of capital competing for these opportunities. No matter what the drivers of returns are, large losses are more likely to follow surges in asset prices, creating more risk for the portfolio. I interviewed the members of one panel, which will be moderated by Nadia Papagiannis, Morningstar’s director of alternative funds research, to get an inside view of this burgeoning segment of the industry. Bradley Alford, Richard Raby, and Richard Bregman have many decades of experience researching alternative investments and managers for clients, and they share their vast experience (“Using Alternatives in Practice,” Page 40). For our 10 Questions feature (“Sophisticated Strategies for the Masses,” Page 16), I also interviewed Henry Davis, a member of the second alternative-investing panel, which also will be moderated by Papagiannis. Davis’ firm, Arden Asset Management, runs hedge funds of funds, and his firm recently launched a mutual fund that invests in hedge fund strategies. He discusses the convergence of the mutual fund and hedge fund worlds and why he believes it will benefit investors. Many alternative strategies were once only accessible to the very wealthy. For better or worse, these investments are being packaged as open-end mutual funds and exchangetraded funds. They are more accessible but not less sophisticated. As advisors, you have a huge role in guiding clients to the most appropriate alternative investments. You are the link to help clients figure out whether they are truly getting the diversification benefits promised by alternatives. I hope the articles in this issue help you with this job. If you have any feedback, let me know via Twitter. Two panels at this year’s Morningstar Investment Conference in June will be devoted to alternative investing and its growth in the advisor and individual-investor markets. 7

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