Time to Rethink Your Portfolio?

When considering your investments and financial plan, it’s important to anticipate changes so you can adapt as needed.

The last few years have spoiled investors—delivering both exceptionally high returns and low volatility. But as signs begin to emerge that the bull market may be drawing to a close, it could be time for investors to look for alternatives. By some measures, the stock market in 2018 has been exceptionally volatile. By April, there had been more up-and-down movements of at least 1% in the S&P 500 than during all of 2017.

Yet to judge by a favorite measurement of financial professionals—the CBOE Volatility Index, or VIX—even this year’s turbulence has been relatively mild. “Over the past 20 years, the VIX has averaged 20,” says Brandon Thurber, Director of the Investment Research Group for Regions Asset Management. In contrast, Thurber says, the VIX spent most of 2017 below 10. “Looking ahead, you can’t assume this will continue, an environment in which you can expect to make money with little volatility or risk of drawing down your portfolio.” That perspective is critical for investors planning for long-term financial goals.

The bad news in the good news

With the current bull market in stocks nearing record length, it’s reasonable to wonder how much longer it can last, particularly as inflation and interest rates head higher, says Thurber. Inflation in particular is a growing concern, as the Consumer Price Index rose to an annual rate of 2.8% in May—well above the Federal Reserve’s inflation target of 2%. At the same time, the Fed increased the short-term federal funds interest rate to 2% in June. That was the second of four rate hikes planned for this year; further increases are expected in 2019 and 2020.

Low unemployment and an economy that Fed chair Jerome Powell pronounced to be in “great shape” are good news, to be sure, but they put additional pressure on the Fed to keep the economy from overheating. And as rates rise and borrowing costs move higher, companies could see earnings begin to flag, leading to lower stock prices.

Bond values, too, could fall as interest rates rise. And while higher yields may be welcome, especially to income-oriented investors, the chance that stocks and bonds—or both—could move down can be worrisome.

“Based on today’s conditions, we believe there’s going to be a market correction in the future,” says Leslie Carter-Prall, Head of Regions Private Wealth Management. “It is difficult—if not impossible—to time the market perfectly, so we’re working with clients in the short term to prepare for various market eventualities.”

One way to be ready, suggests Thurber, is with alternative investments that tend not to hew too closely to the movements of either stocks or bonds. This is a broad investment category that includes a wide range of vehicles, from hedge funds and private equity, to real estate on the less illiquid end of the spectrum, to managed futures and long/short strategies, or funds that hold customized portfolios of alternatives (see “Get to Know Your Alternatives,” page 9) on the more illiquid end. Alternative investments add diversification to a portfolio, which may help reduce volatility when most markets get bumpy.

Know the basics

When most people think of alternative investments, the first one that comes to mind is often a hedge fund. Because of how they’re structured and offered, these portfolios have more regulatory leeway than a standard mutual fund. Hedge fund managers capitalize on that added investment flexibility—the ability to pursue wide-ranging, often opportunistic strategies—to find unique advantages, says Thurber. A U.S. long/short equity hedge fund, for example, can hold stocks as the “long” part of its strategy, but may also take “short” positions, using contracts that let the fund benefit when a stock’s price falls. Other types of funds have the flexibility to implement different approaches.

Diversification, but at a cost

One reason that many alternative investment vehicles can employ obscure strategies is that only “accredited investors,” who meet stringent standards for wealth and income, can allocate to these products. Most alternative funds charge significant fees, based on both a percentage of the assets invested and investment performance. Investors in a hedge fund, for example, might pay an annual fee equal to 2% of the value of their investments as well as an additional “incentive fee” based on the fund’s return that year.

Hedge funds and other alternative vehicles are also less liquid than mutual funds and other securities. Many hedge funds and private equity funds require investors to give up access to their investment for a specified period of several years.

“These are funds that require you to lock up your capital for an extended period of time, often a decade or longer,” Thurber says.

It’s also worth noting that the strategies pursued by many alternative investments carry risks far greater than a typical diversified portfolio. These fund managers, trying to stand out in a very competitive industry and deliver attention-grabbing returns for their investors, make bold judgments about where stocks, sectors and the markets are going, and then invest aggressively, often with significant amounts of leverage to increase potential profits. When things don’t go as planned, the losses can be considerable.

Finding what works for you

The risks and illiquidity of hedge funds and other alternative investments may not pose a problem for younger or wealthier investors who can afford to set aside investment dollars for several years, or who have time to recover from market setbacks.

But many others may want to seek out vehicles that have fewer trade-offs. That’s where liquid, multi-strategy alternative investments, like those Regions offers its clients, come in.

“We can customize these portfolios and take very intentional exposures to particular kinds of alternatives,” Thurber says. “We’re not trying to hit home runs; we’re trying to hit consistent singles, and we view these liquid alternatives as an in-between asset class. Our goal is, over time, to get you to the same place you would be if you just owned a portfolio of stocks or bonds, but to get there with less volatility and lower risks.”

In a typical year, Thurber says, Regions liquid alternative portfolios aim to have returns—and a level of volatility—that fall between those of the major indexes for stocks and bonds. The funds also provide daily liquidity. “Especially during periods of extreme market volatility, liquid alternatives can help provide stability to an overall asset allocation,” Carter-Prall says.

Any decision to use alternative investments depends on a range of personal factors to discuss with your Wealth Advisor, adds Carter-Prall. “It’s important to evaluate where you are in life, the spending needs you’re going to have and the volatility you can withstand as you work toward particular goals,” she says.

But in many situations, an allocation of 10% to 20% in alternatives can make sense, Thurber says. “That gives you some diversification while not taking away from your larger goals, whether capital appreciation or generating income,” he explains. “Alternatives can potentially help prop up your portfolio in adverse market environments.”

Thurber notes that the performance of many alternative strategies has lagged behind traditional investments in recent years. For example, managed futures, a strategy he uses in the liquid alternatives portfolios, have fared poorly during the past several years. “But historically, managed futures have had a correlation to both stocks and bonds that is close to zero,” he says. That could make it a good place to be when traditional holdings falter.

“You can’t invest in the rearview mirror,” Thurber says. “You have to look forward, and the expectation is that going forward, having some exposure to alternative investments could be much more beneficial than it would have been during the past decade. It can help you stay the course as volatility increases.”


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