Alternative investments belong in most portfolios, argues Ted George.

George, a fee-only planner with offices in Palo Alto, Los Gatos and Scotts Valley, Calif., makes it a practice to consider alternatives for most clients. His standard portfolio comprises what he calls level one alternatives, which include real estate and commodities. “These are there not only for diversification, but also as inflation hedges since they tend to go up as inflation increases,” he explains. Their percentage of the portfolio depends on the level of risk specified by the client.

George’s level two alternatives are hedge-type asset classes – although he does not make use of private hedge funds. “About 18 months ago, I researched and found a number of choices for publicly available funds that were doing what traditional private hedge funds were doing,” George says. “These are funds that had been around for a while and had a public track record. Since they’re public funds, you don’t have all the problems of private investments in general and of hedge funds in particular.”

George notes that by trying to provide greater diversification he was hoping to reduce risk, since the markets have become more volatile. He researched and settled on two asset classes that have minimal correlation with other asset classes. The first, market neutral assets, provides a relatively consistent level of earning, regardless of market conditions. The second, managed futures, invests in futures contracts and capitalizes on trends by establishing long positions in certain asset types, hedged with short positions in other asset categories. Managed futures is one of the few asset classes that held up well during the 2008 meltdown.

“Because these asset classes are non-correlated with the other asset classes, by adding these into my portfolios I’ve been able to achieve a positive level of return with reduced risk,” George reports. “So for a moderate portfolio that has a certain targeted mean return, the risk is going to be lower by adding these Level Two alternatives to the portfolio.”