Bay Street Financial District next to the CN Tower in Toronto on Aug. 5, 2022.Nathan Denette/The Canadian Press
The financial industry wants you to get with the times.
The traditional mix of plain-vanilla stocks and bonds is obsolete, they say. It may have worked splendidly for the past few generations, but this moment calls for an evolved approach.
And Bay Street has just the thing to fill the gap in your financial plan: alternative investments.
Once a VIP-only space, the world of alternatives is increasingly opening up to the rank-and-file investor.
Investments in hedge funds, private equity, infrastructure and real estate are widely portrayed as the missing component in a modernized portfolio. Ignore them at your peril.
Problem is, the track record of the alternative asset space in delivering on its promises is questionable at best. The stock market, on the other hand, given enough time, is as close to an infallible builder of wealth as you can get.
Consider a stock-market forecast made 50 years ago by two University of Chicago business alum that seemed preposterous at the time.
The Dow Jones Industrial Average, they said, would rise from the mid-800s, where it languished in 1974, to hit 10,000 in roughly 25 years time, according to a write-up in Forbes magazine from 2005.
This was no shot in the dark. It was based on the idea that equity returns are driven by a combination of dividends, earnings and inflation, and that stock-market performance over the very long term is fairly predictable.
It turned out to be a market call for the ages, with the index hitting its anticipated mark of 10,000 in March, 1999 – seven months ahead of schedule.
The exercise spoke to the stock market’s capacity to generate average returns of around 9 per cent a year, effectively forever, which has helped form the bedrock of mainstream investing.
This number has proven to be incredibly durable. The famous economist Robert Shiller has compiled U.S. stock data dating back to 1871. The average annual return over those 153-plus years, up to the end of last month? 9.3 per cent. (That’s including reinvested dividends).
The Canadian stock market also seems to gravitate to roughly the same result when measured over decades. Since the end of the 1970s, the S&P/TSX Composite Index has posted an 8.8-per-cent average annual total return.
But a new era in financial markets has arisen, or so market strategists around the world are saying.
This paradigm is predicated on the resurgence of inflation and higher interest rates.
Investors are being warned that the decade ahead could bitterly disappoint those who feel entitled to 9-per-cent equity returns into eternity. Plus, the long-standing symbiosis between stocks and bonds has broken down, with both often moving unhelpfully in the same direction.
“A traditional 60/40 allocation to equities and bonds may no longer be enough to meet long-term investment goals,” Blackrock, a global giant of the low-cost index investing movement, says on its website.
“Alternatives can help to lower volatility, enhance returns and broaden diversification of a portfolio.”
This is the great promise of alternatives being touted by the investment industry. That narrative hit a bit of snag in Canada with the collapse of Bridging Finance Inc., a private lender that managed $2.1-billion of mostly retail investor money before being placed in receivership in 2021.
Ever since, the private credit space in Canada has come under scrutiny, with many investors trying to cash out.
Private debt and real estate funds managed by several Canadian firms private lenders, including Romspen Investment Corp., Hazelview Investments, Ninepoint Partners LP, and Next Edge Capital have recently halted investor redemptions.
For the most part, however, these are illiquid investments by design. Their investors, who are typically “accredited” by virtue of higher income and/or wealth, are expected to understand that.
But the industry is busy spinning off new ways for regular investors to get in on the action.
For example, Wealthsimple Technologies Inc. now has venture capital, private credit, and private equity offerings for the retail investor with a higher risk tolerance.
Meanwhile, last October Canadian regulators approved the launch of Obsiido Alternative Investments Inc., which operates a kind of robo-adviser platform for DIY investors to access alternatives.
And funds known as “liquid alts” have been on the market for more than five years in Canada, incorporating hedge fund and private equity strategies in mutual fund and ETF wrappers that can be traded daily.
These funds intended to improve the risk-return profile of a portfolio, while generally charging a premium fee in the process.
So how have liquid alts done? Unfortunately, most categories of Canadian alternatives have easily trailed the S&P/TSX Composite Index over the past five years, according to a recent report by the Alternative Investment Management Association, citing Fundata figures.
Still, liquid alts might make sense as diversifiers if they behave well as uncorrelated assets. But that hasn’t been the case either.
Data provided by Preqin show that its alternative mutual fund benchmark had a correlation of 0.93 to the S&P/TSX 60 Index over the past five years, where a value of 1 indicates a perfect positive relationship. In other words, liquid alts moved in virtual lockstep with the broader stock market.
Perhaps the portfolio of the future isn’t ready to disrupt the old ways of investing quite yet.