Use alternatives to boost retirement portfolios

Retirees and institutional investors share the same priorities.

Both aim to reduce portfolio volatility and maintain steady streams of funds, said Faizan Dhanani, an executive vice president at Horizons ETFs at yesterday’s ETF University event in Toronto.

To achieve this, many institutional investors are shifting away from conventional 60/40 portfolios, he adds. The move is crucial since the correlation between traditional asset classes—such as equities, bonds, fixed income and gold—is rising.

Read: Add alternatives to client portfolios

Along with bond yields dropping from between 6% and 8% to between 1% and 3%, Faizan has found commodities and many large-cap, small-cap and fixed-income securities are performing more like equities.

As such, most major institutional funds have turned to alternatives such as real estate and private equity to beef up their yields. The Yale Endowment Fund has allocated more than half (58%) of its portfolio to alternatives, says Faizan, and in Canada, OMERS has allocated 47% and the Ontario Teacher’s Pension Plan has invested 37% in alternatives.

Since those asset classes are hard to break into for average retail clients, he suggested you help them look for funds that offer exposure. People should also consider investing in ETFs tied to hedge funds, managed futures and corporate bonds to help diversify their holdings, adds Faizan.

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He compares the performance of three example portfolios that were hypothetically invested in the market from December 2002 to October 2013. The first was invested mainly in stocks (55%) and bonds (40%), with only limited exposure to the Auspice Managed Futures Excess Return Index (5%). Its annualized return was 8.09% over that period.

The other two had the similar levels of bond exposure (40% and 35%, respectively) but each cut down on equity allocation (50% and 45%, respectively) to add more exposure to the futures index (10% and 20%, respectively). As a result, their annualized returns were higher ( 8.21% and 8.63%, respectively).

The standard deviation of the two alternative portfolios were 6.76% and 6.33%, respectively, compared to the first portfolio’s 6.10%. However, the Sharpe ratio of the last portfolio—the one with the most exposure to futures—was 1.22, close to the first portfolio’s ratio of 1.25.

Read: Faceoff: Core or Explore?

As a result, Faizan says clients can get higher returns and analogous risk levels by investing in alternatives. To help illustrate this to clients, he adds, advisors need to present data that shows managed futures, or other alternatives, have outperformed major benchmarks such as the S&P 500 and S&P/TSX index before selling them on portfolio allocation shifts.

Read: Is tracking an index worth the cost?

Faizan adds it’s key to maintain both the chosen asset allocations and risk ratings of your clients throughout their retirements. His views mesh with those of PUR Investing CEO Mark Yamada, who outlined during his presentation that determining a risk rating and sticking to it is a good way to construct portfolios.

Yamada finds too many clients are being “dumped into three buckets [low-, medium- and high-risk]. Advisors spend a lot of time on KYC documents and need to tailor more portfolios” for investors.

For more on Yamada’s approach, read: Create Sustainable Portfolios.

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