John Bogle, founder of the Vanguard fund family, has cautioned investors for many years about playing cute with their investment portfolios. “Don’t look for a needle in the haystack,” says Saint Jack, “just buy the haystack.”
With that, Bogle inveighs against stock-picking and advocates the use of index funds. Why try to beat the market, in his view, since you can’t do it consistently?
Not surprisingly, many investment advisors rail against Bogle’s notion. Some, particularly those running endowments and foundations, are duty bound to seek equity-like returns without the concentrated risk of stock investments.
Which brings us to alternative investments. Mixing “alts” into a portfolio can, in the best of circumstances, enhance returns and diversify risk.
This year, though, alts have had an especially tough row to hoe. Domestic equities, measured by the performance of S&P 500 SPDR ETF (NYSE Arca: SPY), gained 15 percent in 2014 with an annualized volatility of 11 percent. A stand-alone investments, only one alt category outperformed the domestic stock market.
Alts, of course, aren’t meant to be stand-alones; they’re destined, for most investors, to be portfolio adjuncts.
Real estate was the standout of the year, offering a one-two combination punch of outsized gain and low volatility. The PowerShares Active US Real Estate ETF (NYSE Arca: PSR) more than doubled SPY’s return with a smaller standard deviation. All this with a middling correlation to the broad equity market.
If you were shopping for negative correlation to equities this year, the shelves were rather bare. Only two ETFs — the SPDR Gold Shares Trust (NYSE Arca: GLD) and the QuantShares US Market Neutral Value ETF (Nasdaq: CHEP) — cranked out negative coefficients against SPY. And the price for this? Negative returns, though arguably you could say GLD had a breakeven year.
If you base your diversification success on the Sharpe ratio — a gauge of risk-adjusted returns — this year’s runner-up alt bets were managed futures and absolute value, epitomized by the WisdomTree Managed Futures Strategy ETF (NYSE: WDTI) and the HedgeIQ Real Return ETF (NYSE Arca: CPI), respectively.
The derby for 2015’s best and worst kicks off today. Stay tuned for ongoing updates.
Brad Zigler is former head of marketing and research for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.