Rydex SGI's Abernathy Talks Up Alternatives

SAN FRANCISCO -- Alternative investment strategies are relatively new. But they've already achieved broad acceptance within the investment world, Jerome Abernathy of Rydex SGI told a packed gathering at the Schwab Impact conference in here on Wednesday.

And, he said, they will be increasingly critical for advisors who want to generate yield for their clients while also protecting them against systemic financial shocks.

“Twenty years ago, Nirvana was considered alternative rock,” said Abernathy, director of research for Rydex SGI, an asset management firm owned by Guggenheim. Today, “we call them classic rock,” he said.

Alternative investments and strategies include hedge funds, commodities, managed futures, long/short equity and event-driven strategies. Broadly defined, alternatives are anything outside the traditional investment toolkit of stocks, bonds, cash and real estate, and all provide exposure to sources of return aside from capital appreciation.

Though the name alternatives makes them sound exotic, Abernathy pointed out that managers of the largest endowments and pension funds rely on them, in large part to protect against large, global risk events like the credit-driven downturn in 2008 and 2009.

And, he said, managers of endowments for Harvard University and Stanford University don’t dabble. They put anywhere from 20% to 30% of their endowments into alternatives.

“If you only allocate 5% to 10%, it actually doesn’t make a difference,” Abernathy said. “It’s not until you get out there towards 20% or greater that you see a real material impact.”

Abernathy said he conducted a study of how allocations to alternatives affected overall portfolio performance under a variety of scenarios over the past decade or longer. He focused on different categories of alternatives to gauge their ability to hedge against risk and generate yield, he said.

Three of the risk events he analyzed included the post-9/11 period, the equity crisis from April of 2000 to September of 2002 and the credit-driven crisis that ultimately spread to housing in the latter half of 2008.

To hedge against these types of risk events, Abernathy urged advisors to take a portion of the riskiest chunk of their clients’ portfolios — usually equities — and invest that in alternatives. He suggested managed futures as a good bet. “If you had to allocate to one strategy in your portfolio, I would say go to managed futures,” he said.

To prove his point, Abernathy put up a slide (pdf link available below) showing a hypothetical allocation to managed futures over the past decade. With a 20% allocation to this alternative, the fund returned 5.47% annually versus a 21% drop without the allocation.

The first question from the audience came from an advisor who said he used to work for a hedge fund and was having trouble convincing his colleagues at his new firm to invest in alternatives.

“How do I overcome that resistance to the strange, the new, the different?” he asked. “How do I overcome that fear of the unknown?” Abernathy said the advisor should show his colleagues the data. “See what Stanford is doing? See what the MacArthur Foundation is doing?” he suggested the advisor say. “They’ve been doing it for years.”

Another planner took the microphone and said, “Keep pounding on them. They’ll come around.”

Yet another audience member suggested the following: “If you can offer (alternatives), that gives you a competitive advantage over other advisors. It will (also) improve your performance over time.” And that, he said, in itself will draw in more business. “It’s kind of like climb on or miss the train.”

 

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