the broken typewriter

By Brad Brain

One of my dominant personality traits is that I am a fact-finder. Many times it is just not good enough to simply tell me something. I am going to need more than that. I need to see the proof for myself. I need to see the facts.

In my profession, this trait has served me well over the years. Because people tell me stories all the time. And, sometimes, those stories just don’t add up.

Take, for example, the resurgence of alternative investments. If you listen to some of the stories, alternative investments are the magic elixir that will answer all your financial prayers.

Traditional investment vehicles, such stocks, bonds, real estate and bank deposits,

will all have their pros and cons. Because there is no one perfect investment, some people are always trying to figure out if there is a way to make some improvements.

Alternative investments, collectively known as “alts”, are sexy. Private equity. Private credit. Infrastructure. Private real estate. Hedge funds. Absolute return funds. Special situations. The language of alternative investments can make you feel like its an exclusive club with special perks.

But there are some drawbacks too. Alternative investments can be complicated. Their investment strategy and fee structure can be opaque. The transparency of their holdings can be lacking. The accounting standards can be flexible. They might be exposed to additional risks, especially because of the use of leverage. And your ability to access your own money can be restricted.

The alternative investments story is always some variation on above-average performance, or below-average volatility, or both. The various nuances are not important for the purposes of this column.

All you really need to know is that alts promise more. Promises of better performance. Promises of lower volatility. Promises of something special. It’s a good story. But I am going to need more than just a story. I want to see the proof.

The seeds for this column were planted when I attended an investment conference that was heavy in alternative investment content. I am an open-minded guy. If something has the potential to be beneficial, I will listen.

I was listening to one presentation, and they were talking about their target rate of return being 7% to 9%. That left me underwhelmed. 7% to 9% is not that special. It’s in line with historical average for the Canadian stock market.

Another presentation was talking about how these strategies were used by university endowment funds and pension plans. But these funds also lost money. I didn’t see why it mattered that the firm had big clients. Losing money is losing money.

More recently I was talking to other advisors at two different firms. Both were very happy with the alts that they were using because they lost relatively less money than the benchmark stock index in 2022, which was a bad year for many asset categories. “So what?” I thought. The stuff I used in 2022 didn’t lost money at all. In a tough year, they were happy that they didn’t lose much for their clients, but I actually made money for clients that year.

These same other advisors were telling me how good the long-term performance of their alts had been. “So what?” I thought. The long-term performance of the stuff I used was even better, with less risk.

But, if they performance is not any better, surely alts will protect you from catastrophic losses then, right? Nope. Lots of alts have been wiped out.

Meanwhile, alternative investments almost always have reduced liquidity. Sometimes a lot less. Sometimes you can’t get your money out for years. There’s even a term for it. “Gating” means that a firm has suspended redemptions. In other words, you are stuck. You can’t sell. You can’t get your money back until the firm lets you. At least three firms in Canada have gated their private real estate funds this year.

My point is that there is a lot of noise about alternative investments. But when you look at the actual results, I find them wanting. Alts tell a good story. But I’m going to need more than that.

I am still waiting for the proof that I should incorporate alternative investments into my client’s portfolios. It would be one thing if the target rate of return was significantly higher. Or if the long-term performance was better. Or if it helped me avoid big declines. But I don’t see that.

So why would I put client’s money in illiquid assets unless there was a clear payoff? A fancy story without supporting evidence is just a sales pitch. I am going to need more than that.

I am not saying that all alternative investments are bad. I am just saying I am going to need more than that before I can say that they aren’t.

Brad Brain. CFP, R.F.P., CIM, TEP is a Certified Financial Planner in Fort St John, BC. This material is prepared for general circulation and may not reflect your individual financial circumstances. Brad can be reached at www.bradbrainfinancial.com.