Currently, we think investors should focus on U.S dollar-based assets that can thrive in an environment of heightened market volatility that also offer relatively stable yields. These types of strategies include:
Preferred Stocks: These strategies can provide a good relative value compared to other income producing sectors. Since preferred securities are lower than debt issues in a company’s capital structure in the case of default, investors may want to look for a strategy that has an active management overlay to offer the added benefit of bottom-up credit research.
Diversified Multi-Asset Income: These strategies can offer a blend of income producing assets, such as mortgage REITs, preferred, and high-yield bonds. They are diversified blends that offers relatively consistent returns, primarily through an attractive yield, and potentially low correlation to the traditional stock and bond markets.
Options Writing: These strategies typically profit from a higher volatility regime by selling call options on an index. As volatility increases, so does the potential options premium. Additionally, many of these strategies reinvest the premium it receives to potentially increase the fund’s net asset value over time.
Merger/Arbitrage: These strategies have a history of solid performance in volatile equity environments because of their ability to short equities. Merger/arbitrage investments generally makes their returns based on the price differentials between companies being acquired and those doing the acquiring.
MLPs: We think the energy sector is one of the most attractively priced areas of the U.S. market based on normalized earnings. Given the combination of positive fundamental and technical factors, we expect oil prices to stabilize near or above their current levels. Energy companies should also be able to increase earnings nicely at these levels. Additionally, MLPs can provide a nice yield.
Below is an example of how an investor might allocate these strategies to create a basket of alternative investments. The expected current yield on this basket should get an investor a long way towards our long-term total return expectation of 6.5% for the basket with significantly less volatility than the equity market and less interest rate risk than the traditional bond market.
Importantly, because investors can use ETFs, these alternative strategies offer intra-day liquidity, rather than the longer holdings periods required by many alternative investment vehicles. Furthermore, many of the alternative ETFs are subject to 1099 tax reporting and not the more complicated K-1s. Lastly, using ETFs should be less expensive than hedge funds or even the average alternative mutual fund.
Combined, a well thought out allocation of alternative investment ETFs can offer an attractive risk-adjusted total return, a healthy income stream, less risk than the equity market, and efficient tax reporting in a low-cost product. This type of allocation may be a great solution in today’s shifting economic and market environment.