The Alternative Answer: The Nontraditional Investments That Drive The World's Best-Performing Portfolios

Book Review: The Alternative Answer: The Nontraditional Investments That Drive The World’s Best-Performing Portfolios by Bob Rice.

Bob is the Alternative Investments Editor for Bloomberg TV and is the Managing Partner of merchant bank Tangent Capital, and serves on boards of investment management firms with over $2 billion of ‘Alternative’ assets under management.

The Alternative Answer is divided into multiple sections:

The Alternative Manifesto
Major Alternative Strategies
Major Alternative Structures
Higher, Inflation-Protected Income (Job 1)
Broadening the Base for Risk Reduction (Job 2)
Long-Term Growth Enhancement (Job 3)
Purchasing Power Protection (Job 4)
Big Picture
At the Dealership
References/Glossary

Manifesto:  There are four mandatory tasks for investments:

  • Job 1: Generate income that is greater than typical fixed income (bonds), with focus on income that rises with inflation.
  • Job 2: Reduce overall risk by diversifying broadly across different strategies and asset classes.
  • Job 3: Enhance long-term growth with opportunities that have more upside than traditional investments (stocks).
  • Job 4: Protect Purchasing Power from inflation, currency devaluation and panics.


Strategy Notes:
A portfolio should be ‘panoramic’ – Highly diversified across different asset classes, strategies, and time.

The portfolio should be risk-tolerant in 3 ways:
1) Most liquid securities should be ACTIVELY managed to protect against loss.
2) The portfolio returns should be UNCORRELATED.
3) The portfolio should be “absolutely diversified”, focused on VULNERABILITY (event) diversification.

The biggest owner of timberland in New Zealand is… the Harvard Endowment Fund.
Harvard’s 2012 portfolio:
12% U.S. Stocks
4% U.S. Bonds
84% “Alternatives”

Correlation kills. As an example, think you’ve got a reliable phone, TV, and internetconnection by ‘bundling’ your services with a single provider?  Ask anyone whose house was hit by Tropical Storm Sandy what happens when a tree falls on the cable line.  Bob makes a statement that thinking you are ‘diversified’ by purchasing a stock index is like declaring you have just eaten a balanced, nutritious breakfast by eating five different brands of cereal.

There is a ‘Great Investing Schism’ between the economists who follow Modern Portfolio Theory versus the Behaviorial Economists.  Bob compares this divide to Old School physicists who follow the Newtonian model versus ‘New School’ physicists following Einstein’s Relativity Theory.
   Modern Portfolio Theory (MPT) holds that ‘Everybody knows Everything about Everything’, the knowledge playing field is level, and that everything is alredy priced in to the market or specific security. Under MPT, your best bet is simply to diversify across different asset classes.  Bob refers to the MPT school as “Converging” (matches the market) strategy.
   Behavioral Economists believe that people are Irrational, and that ‘Black Swan’ events (like the collapse of the Internet Bubble, the Housing Bubble, and the 2008 Credit Crisis) can and WILL happen again, and that you should be prepared for them.  Following the Black Swans is a “Diverging” market strategy.

Structures:
Average Joe investors like you and me are no longer stuck with the “Kid’s Menu” of asset choices.

“Hedge Fund” is way too generic of a term to describe what is going on with a hedge fund.  There are thousands of hedging strategies dealing with different risks associated with market bias, nationality, events, currencies, etc.  Bob goes in to some details on how simple strategies like the long/short strategy– Go ‘long’ (bet in favor) of one stock that you think is well-run, go ‘short’ (bet against) another stock in the same industry that you think is poorly run.  If you are correct on your bet (the well-run company will perform better than the poorly run company), then it does not matter whether or not the industry tanks, skyrockets, or goes sideways.  What matters is that the well-run stock performs better in RELATION to the poorly-run stock.

Bob goes on to mention fascinating alternative concepts like “reverse IPO’s”, “managed futures” (not the plot of the movie ‘Gattaca’) and “registered privates” (which are neither enlisted soldiers nor the Database of Sex-offenders).

At the Dealership:
Breaking it down in to action, Bob recommends different strategies for scenarios you think may happen (inflation, deflation, credit panic), and overall recommended allocations to perform Jobs 1 through 4.  He also notes that for beginner to intermediate investors, ‘Black Swan’ funds are not available, but CASH IS THE POOR MAN’S BLACK SWAN FUND.

In recommending allocation, Bob starts by introducing the concept of your personal “Liquidity Ratio”, which calculates net worth versus your annual spending.  People with higher ratios can and should pursue more alternative investments, people with lower ratios should pursue some or none.

As an example, a mid-career employee with a respectable 401k balance and reasonable standard of living should devote about 30 percent to alternative investments.  And of the alternative investments, they should be broken down as:

  • (30%) Job 1 (Income): MLP’s, multiasset ETF’s, Emerging Markets debt mutual funds, royalty trusts, BDCs, Floaters.
  • (35%) Job 2 (Risk Reduction): Smart Beta and multi-alternative mutual funds, TREITs, cash.
  • (25%) Job 3 (Enhance Returns): Long-Only US Stocks, Global Blue Chips.
  • (10) Job 4 (Inflation Protection): TIPS (Bob notes that there is a ‘right’ and ‘wrong’ way to purchase TIPS).

CONCLUSION:

Praise for “The Alternative Answer“:  It’s a fascinating and accessible read- The book explains complex investing concepts in understandable terms.  Reading it provided me with as many questions as answers-  I’m going to do some more ‘Alternative’ research on my own.

Recommendation for “The Alternative Answer“: It would be nice for Bob Rice to have listed some specific ETFs or funds to go with each specific strategy.  Anyone picking up this book to begin with should be sophisticated enough to realize that ‘This book is not a solicitation to buy or sell securities‘.

Action for Feds:  There’s not too much you can do with ‘Alternative Strategies’  inside your TSP, other than hoarding a bit of cash in the G Fund as a ‘Black Swan Event’ hedge (that is, buy the S, C, or I Fund next time there is a crash).  Outside of the TSP (your taxable accounts or IRAs), the world is your oyster!

More information about the book and alternative investing is available at Bob’s Website: AltAnswer.com.

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