Why Diversify?
From the last OpenAlt conversation, we know alternatives can be powerful tools to enhance return and/or mitigate risk in an investment portfolio. With AUM in alternatives expected to grow from 18% to 24% by 2025, it is the perfect time to understand what diversification is, and how this information can help you think about building a portfolio. How can alternatives potentially play a part in a diversified portfolio?
Hosted by OpenAlt, Chris Carsley - CFA, CAIA, Chief Investment Officer & Managing Partner at Kirkland Capital Group continues the series on alternative investments.
“I’d like to think that there are two factors of why you’re doing diversification. First, I’ve got a target return that I want for my portfolio. Second, I don’t want to take on undue risk. “
- Chris Carsley
“When the market goes down, you have an asset that actually tends to rise in value as others fall, which they call countercyclical.”
- Chris Carsley
“A lot of people’s portfolios are not as diversified as they think.”
“If you’re looking to put together a portfolio of instruments you would want to maximize diversification, that is having different assets that are not correlated with each other.”
Watch the discussion below.
Transcript
Rachel: All right. I will go ahead and start. Thank you everyone for joining us for part two of our webinar, where we go over. Why diversify? My name's Rachel, you're the co-host for today. I have experience helping sponsors and those who wanna invest utilizing a retirement account in alternative investments. I will pass it over to our co-host Chris Carsley.
Chris: Hi Everyone. Thanks for joining us. Yeah, last time we came on, we talked about what are alternatives and we walked through the high level of, what is an alternative and how you should think about that as an investor today, we're gonna dive in a little bit and talk about diversification.
Why should I diversify and end off with, in our current timeframe of the advancement of the access to alternatives and how that could affect diversification within your investment portfolio. So let's go ahead and jump in and we'll walk through our agenda. First we're gonna be walking through, we have movement in our slides.
There we go. First, what is diversification? Then we're gonna talk a little bit about why diversify cuz that's an important aspect and there is actually some debate out there of, what is proper diversification? What has changed recently? There's been a lot of things that have changed since the forefathers of diversification and people building portfolios which started back pre 1950s, but was made popular by Markowitz in 1950. And I think most of you probably know that name if you've done any research on diversification. But then why alternatives? Why would we add alternatives to an investment portfolio that you know, where we've seen a situation over the last 10 years that, traditional investments maybe even the plain old 60/40 portfolio has done quite well.
So we'll talk a little bit about how alternatives have actually worked in the past and how they might be a good allocation going forward for someone's portfolio. And then as I always like to end with, we'll walk through some of the next steps. And then, we got some more information coming in.
Some other webinars that we'll talk about towards the end. So let's dive into what is diversification. Simply put, there's no way to escape the math. Diversification is a mathematical process to develop a strategy when looking at a variety of different investments within a portfolio to try and optimize a return given a number of return characteristics for a portfolio. Now I put a little description in this slide to talk about the extended version of this. Cuz if you go to Investopedia they won't talk too much about maintaining return aspects, but they'll basically say, Hey, this is about just mitigating risk.
I like to think that there's two factors of grading and why you're doing diversification is. I've gotta a target return that I want for my portfolio, but I don't want to take on undue risk. If I'm just trying to meet that required return, I wanna maintain a risk level that is something that meets my risk aversion level or various particular liquidity needs or other things that I might need for my individual portfolio. Cuz you know, we're all different. So diversification for you, don't go out there and try to copy someone else's ideas of their personal diversification, cuz you might have factors that are affecting you that are monumentally different.
And I know that's a little bit of a challenge. You can use some of that as reference, but at the end of the day, You need to, yourself or your financial advisor needs to develop a plan that really is creating proper diversification in your investment portfolio for you. So let's dive in. Next slide.
As I said, There's no way to escape the math. We will not be going through and delineating these formulas. But I like to just throw it in there. These are some of the core ones and actually cover the majority of what you need to assess and think about if you're gonna be diversifying your portfolio.
Now what's really nice in today's world is this is actually done by a lot of software programs. Most of your RIAs, your financial advisor have software that already will calculate most of this. And you just really have to fill in the particulars of, your risk aversion, any kind of liquidity needs, any other types of things like, Hey, I don't do certain types of investments or I don't, I don't like lockups longer than 10 years, whatever that might be.
They can, they have software programs that can go in and help you adjust this and run these calculations behind the scene. So I just wanna throw it up there cuz some of these look pretty scary and some of 'em do get rather complex, but we're not gonna be diving through that. But we do unfortunately have to talk about the mathematics behind diversification cuz that's really what the process is.
Next slide. What do we need to understand if you're new to diversification and you're now looking at your portfolio, which I know a lot of people are right now. There's been some volatility in the markets. Maybe that traditional 60, 40 portfolio of just long stocks and bonds is not working for you.
It's not meeting your objectives. You need to look at what you have in your portfolio. And think about what you'd like to add to your portfolio and whether you're looking at one side or the other, you need to understand these components. One, what is the expected return of the investment? Now that can be confusing for some people who haven't thought about this, cuz is that really just, oh, what was the past return?
Not really. Now obviously the best indicator of what will happen in the future. According to Forecasting 101 is what happened last? So it gives you an idea. You gotta understand. What are we thinking our investments gonna be returning for the future. So for instance you can go get a lot of different information from wall street papers and white papers.
There's a number of people who've built forecasting models to say, Hey, I think for the rest of 2022 or whatever year we're in. This is the expected return for equities. This is the expected return for debt. I know that a lot of people have felt some pain in 2020. So understanding that expected return of that forward looking return is extremely important.
Then the standard deviation here again, It's one of those mathematical calculations I had on the other page, but this is a calculation here again. That is a very common place. A lot of your financial advisors will run this and it's to understand what is the underlying general volatility of this instrument?
How much does it generally move up or down given, general market moves? So for an easy example, obviously, equities are more volatile. So they'll have a larger standard deviation around what they call a centralized or mean return. Obviously fixed income. Although we haven't seen that recently generally has a muted standard deviation.
It is less volatile, which is one of the reasons people add fixed income to their portfolio is further diversification. And the ability to perhaps capture income on a regular basis. And also if there's an immediate need for sale or liquification, you can sell perhaps fixed income at a, after it's already moved down a lower move than something that may have occurred in equity portfolio in say a negative market move then risk free rate.
This is needed just to assess well, If I did nothing, what can I get as a return? And a lot of people generally use this. And the easiest way to think about this is what's the 10 year treasury. A lot of people use that as an indicator of what is today's risk free rate. If I didn't want to invest in equities or bonds or anything else, I just wanted to make sure that my principal was going to be there.
We're gonna invest in the US 10-year treasury. There again, that's just a measure. We're not gonna dive too much into how that's all used in the equations, but these are the factors you would need to understand if you're gonna try and do this yourself. And then lastly, and probably the most complex aspect is the correlation between all these assets.
So obviously this becomes more complicated. If you have only two assets in your portfolio, you buy one stock and one bond. You only have to be concerned. How do they react with each other? And that's probably the easiest. Now, I don't think anyone maybe has a portfolio quite that simple. You may have 15, 20 different things and understanding all the moving correlations between those assets.
So when the market goes down, though, you have an asset that actually tends to rise in value as others fall, which they call countercyclical. So I put in a little definition down at the bottom there. It's a statistical measure that expresses the extent of which two variables are related.
Another way to say that is, do they tend to move in tandem or do they move counter from each other? So obviously you're looking to put together a portfolio of instruments, if you're trying to maximize diversification, things that are naturally not correlated with each other. So that's one of the things that you're trying to build.
And that's easier said than done. And we'll talk about this a little bit later, cuz sometimes what you've heard a lot, if you've been keeping up with what happened in oh eight or a flash crash or what happened in the pandemics or what happened recently? Or any other future event where we have uncertainty in the market, you'll find a number of different assets start to correlate more than they do in normal times.
So a lot of people's portfolios are not as diversified as they think.. So just some things, to think about when you're going through and thinking about these moving factors let's move to the next slide. Let's dive into a little bit of why diversify. And as I said earlier, there's a little bit of debate about this of what proper diversification means, whether you're talking to somebody who's rooted in statistics or you're talking about someone who's a true market tactician. And there's a lot of people that say Hey, you should own 30 plus different items. I think that. Has narrowed down over the years. There's some very famous names that have said, Hey, you may own as little as 15, if you've done proper assessment of those investments and understand the correlations.
So it is a little bit of work to understand what is my current diversification? And hopefully there again, your current financial advisor, your RIA, or if it's something you do on your own that you have a model that allows you to really understand that and where we are, in today's world.
But at the heart of it, we're trying to control risk.. The old adage of do you wanna put all your money into one investment? I E you know, everything in, one egg in the nest. We all know that's probably not wise. There are people who've done that in a material way and got lucky.
I think that is extremely rare. I think if you are looking for long term growth and. Perhaps investment management is not something you do professionally on an ongoing basis, or you have an edge that's consistent. I think you need to be looking at diversification. I think everyone generally agrees that one investment would be unwise and maybe even, as small as, Less than 15 might be unwise, because one of the things that I'd said is a lot of people don't realize they go out and invest in 10 different things and they say, wow, I'm diversified.
I own 10 things. Then the market collapsed. And they realize those 10 things weren't as diversified as they may have been historically. And that person, unfortunately now is in a situation perhaps their entire portfolio fell and they need liquidity and they're forced to sell towards the bottom. So you are trying to mitigate risk and risk usually occurs in an uncertain time.
You have uncertainty in the market. You don't know exactly when it's gonna happen. So we need to be proactive and think about why we're building a portfolio and how we're gonna be controlling that risk going forward and investing across a multitude of different assets. And we'll talk a little bit about I think most everyone here has probably been long stock.
Long bonds. And now we've got greater options to add a variety of other assets that have lower correlation and perhaps still meet the required returns you want for your portfolio. The second box there. I'd just like to throw it, oh, back up one slide there cuz I, I have a lot of people that when I talk about diversification they under, they, oh, I totally understand diversification.
I said what's your risk adjusted return you're looking for. And they go, I don't know what that means. And it makes me laugh cuz it's like when you're, that's literally the end product of . Diversification is the control of risk within trying to create a targeted return. And what you're trying to do is the numerator of your equation and say, Hey, I want an 8% return and I don't want a volatility greater than 10%.
Okay. That's the base equation and a lot of things. And one of the famous ratios that I think a lot of people might know about is the Sharp. Created by Mr. Sharp eon ago. It is a good indicator of. What's the general return given the standard deviation or the underlying volatility of a base asset.
And it can give you an idea of, okay if you put together all those pieces and create a portfolio and understand the sharper issue of a portfolio, it'll give you an idea of unit of return per risk you're taking. And is that acceptable to what you want now? Don't hang your hat on the sharpe ratio, but it is a good indicator of that first steps of thinking about risk adjusted return. And so it's something that if you haven't thought about that yet, yet you want to go into diversification, ask some questions, get some white papers, get in there and educate yourself about risk adjusted return, cuz that's really what you're creating at the end of this process.
When you're going through and thinking about diversification over a portfolio, next slide.
All right. What has changed a lot? A lot has changed in today's world. The first box, there is globalization of markets. And the reason I bring this up is back when I first started and I was putting together portfolios for investors. It was pretty easy to say, Hey, I could have my US exposure and I could truly go out and buy an ETF or a mutual fund in another country.
And you would have a relatively low correlation between those assets, because what occurred, say in your, in the US and to your US investments, wasn't occurring in another country. That's not so much the way it is today. We are in a global economy. We are more connected than we've ever been historically.
And I don't see that changing anytime soon, as we've seen multiple times global events occur and there's an immense impact to our markets, both, both actual physical markets and the investment markets, which causes, either a boon to the stock market or stress and downward pressure on our investment markets.
Global events like when the US now, if you are looking at, a Fed tightening policy that affects the globe more than it ever has in the past. And so why I mention this is the old adage of go by some, foreign ETFs or foreign equities. Make sure your financial advisor and you have the discussion about just adding those pieces.
Are they as powerful diversifiers? As they've been historically and if not okay. Make sure you're sizing it correctly. So the globalization of the financial markets has created greater correlation amongst a lot of different, traditional public instruments. So something to be aware of. Next, the proliferation of investment.
I think it was a McKinsey and company came out recently and they were tracking global investments and it was back in 2000 global investments were around 440 trillion. And then in 2020, I think this report I was looking at ended they said it was 1,540 trillion.
That's an increase of 250% in total dollars of, of their assessment of what's out there. Investments that they can get ahold of. And they were trying to get as much as they could from the private side, not just the public side as well. What that generally says is there's more dollars in play and you have more investors involved and there's larger movements of money.
So now, We'd all like to think that when I go sell Apple that other people would care, but I just don't own enough of a company that large, that my sale would affect anything. But what you are seeing is the aggregation of people's funds into very large pools to where you can have.
Large global investors make decisions one way or another or countries make decisions. And just that larger investment pool is creating market impact there again, that can increase in times of stress when you have large dollars moving. That will create what I was talking about, where, the old adage of increasing stress, assets correlations go to one, which is, it's a misnomer to that, but you do see an impact that doesn't go to one, but you do see an increase in the correlation.
And a lot of that is there's just more players in the game and more money moving. So there, again, something to think about, it's a more global world, there's more money moving, larger pools of money moving as people tend to aggregate their money. Next is increased understanding of, risk and return.
And this is an important one because as risk management became a mandatory tool for portfolio management, even on wall street, back in the eighties. I know a number of people who were working at shops and working in this new idea of risk management. But now it's pretty commonplace and we've actually advanced a number of ways of thought around how to think about the risk within a portfolio.
And people have been able to break it down into various risk factors, and why this is important is if we're gonna make a return on anything, we're taking some level of risk. There are. Are true arbitrage opportunities where I can make a return and I didn't take any risk. They do exist, but they're far and few between, and as smaller investors, we're probably unlikely to capture a true riskless arbitrage.
So in our world that we work in, we are taking some level of risk and we're making a return of that. Okay. Understanding and being able to there again, work with the people who are helping with your portfolio. What risk am I exposed to? What affects various instruments that I own? So give an idea of some of the risk factors, equity risk.
Okay you invested in equity, you've taken an equity style risk. That is a risk factor. There is a premium to that because you have a greater volatility in that investment. So you hopefully are rewarded. Over a certain period of time for that risk. You got interest rate, risk, currency, risk, liquidity risk.
So going in and there again, we're not gonna dive into all of these, and this is not the purpose to go into the nuances of risk factor and risk factor based investing. But it's something to be aware of that information is out there. There's a number of different white papers that have been created over the years to help you understand.
And I think this is important. Because you want to understand what you're exposed to and why you're making the return you're making. I run into it a lot and it's really unnerving cause I'm not in the business of arguing people's beliefs, but I run into a lot of people who are making a return and they feel like they're taking no risk.
And I've had a lot of people, especially now that I'm more involved in real estate. There's a lot of great trades out there, but people feel they're making very large returns without taking risks. And that's just not possible. You are taking risks and often not a lot of people are taking equity style risk yet.
They think they're at the debt level and it's just, they haven't thought about the risk factor. And it's one of the reasons I put it in there, cuz I do run into it a lot. As people are becoming more complex in the level of their thinking of investing they're fooling themselves or they're not being told properly what risks they're actually exposed to and how the trade could break.
And that's a good way I'll end on this and we'll move on to alternatives. Is. If you're gonna be looking at something, always think about how could it break, cuz that will lead you to think about what risk am I actually taking? Because that, that's what you're exposed to and that'll identify that factor.
Lastly, alternative investments. There has been a massive explosion of a number of different rules and regulations, allowing investors greater access to alternative investments. And here again, for people who didn't get a chance to watch the last seminar we had an alternative investment is simply put, is.
Really any other investment, that's not long stocks and bonds. And that can encompass a variety of different things. Hedge funds, venture real estate special sit trading, structured investments. There's tons of them. So if you get a chance, please go back and watch that and you'll understand what I'm talking about with alternative investments, but the access to alternative investments and the risk factors that those in alternative investments earn their returns is usually differentiated.
From your traditional market. So it's one of those things. It's one of those points that I'd mentioned earlier of why turn investments might be a decent add to your investment portfolio is because you're thinking about I already have a lot of equity exposure. How else can I get a return? And maybe it's equity exposure within real estate.
Maybe it's something where, oh, I'm gonna go take a crypto exposure. Now be careful, cuz we've all learned that crypto had a much higher correlation to technology than everyone imagined. And everyone's experiencing that right now, but think about a variety of number of alternatives and think about, okay, how am I generating that return?
And those are more accessible. So you've got a number of crowdfunding platforms. You've got a number of different ways to access. More alternatives. There's been, like I said, changing regulations in crowdfunding. There's entire companies that are based on REG A and they're trying to democratize and give access to smaller investors for smaller dollar amounts to alternatives.
So lots going on in that place. And If anybody wants to talk further about, oh, how do I access a number of these things? Great. We can take it offline. We can answer, put some questions at the end of this. Love to help you think about how do I best access alternatives?
We can move on to the next slide. Let's dive in. Why alternatives for the future of diversification? I covered some of this already in my ending statements. The last slide. Correlations of traditional investments, increase in times of volatility. We talked about that earlier of Hey, in a time of risk and there's a great deal of uncertainty in the market.
That creates fear. That fear can make everybody try to run for the same door at the same time. And when that occurs you're going to get Everyone trying to sell whatever they can. If people remember back in the great financial crisis, which I just deemed oh eight you had anybody trying to sell anything they could get, whether it was good or bad, it was just what ATM can I access?
Not all alternatives are gonna be prey to that. Some alternatives. Have an illiquidity component to it. Use venture as an example, when you invest in that, you have to understand the duration. You could be in that investment for 5, 7, 12 years as that portfolio of venture companies liquidates.
And so that illiquidity is not gonna be so subject to. Quick downward gap moves. So if something like give, COVID, March, 2020, you had a big move down and things had recovered quite quickly. Within the venture world, that was pretty muted. That wasn't something that really affected them immediately.
You didn't see volatility in your portfolio, so a number of different alternatives won't be subject to that. Now. There are some alternatives, specifically, it is a class of alternative called global macro, where they're trying to track trends and be on the forefront of movements, given a number of different indicators.
We're not gonna go into it. It gets pretty complex, but they tend to be a counter cyclical trade where, Hey, the market's volatile. Everyone else is going down. As people are forcing to sell. And that particular strategy tends to move up and show strength. Lots of things to think about, why an alternative would be good just simply because it has either counter, counter low, maybe even negative correlations or doesn't, have massively shifting correlations in time of stress.
They can provide excess return to comparable traditional assets that has been basically proven mathematically. Whether you're looking and saying, Hey, maybe a piece of my equity portfolio, I should think about something within private equity where it's taking. And equity exposure, but with a different risk profile and it can create an excess return due to a number of different factors.
Maybe you're playing, earlier venture or something of that nature. You can capture maybe a little illiquidity premium. There's a lot of debate of how much that is these days, but there's a number of different factors that you'll be exposed to by being in private equity that you won't necessarily be in, traditional equity.
One of the things that there's private debt has been a huge explosion since oh nine. So if you can get into private debt and take advantage of the inefficiencies of where banks are not able to lend to a lot of different companies or maybe a real estate project or something like that, you often can capture an excess return for taking very similar risks and still gain a fixed income.
Where you have the ability may be monthly or quarterly payouts. So you'll see a lot of alternatives have similar structures to the traditional, but they're capturing some level of inefficiency or have a different structure that will create an excess return. We've already hit the third one in multiple fashions is providing returns from a differentiated risk factor.
I'm not gonna talk too much about that. Cause we've really covered that in multiple aspects. But yeah. And then lastly, some strategies are built to hedge or dampen. I've mentioned this earlier. I wanna reiterate this. There are market neutral strategies there, you don't run into too many more short biased strategies anymore, but like I had mentioned global macro, a lot of your trend falling. Maybe if you want to come up the curve and educate yourself on managed futures, those strategies tend to be all countercyclical. They tend to have strength in times where you are seeing uncertainty in the market. And I know that can be difficult. I've thrown a lot of different names at you.
But you can research and access those. And there are sites that, both open alt or myself can get you so that you can go in and have further resources to understand some of those strategies, if you are at that level. And you want to add those to your portfolio as you can see, overall alternatives are adding an additional selection piece of how to access different risk factors, excess returns, and perhaps in volatile markets, you won't experience the volatility within these alternative investments.
And I think given what we've said, you can now understand why we threw this in there. Thinking about alternatives. in the future of your portfolio is. If you think about what's my excess return or what's my expected return. What's my standard deviation of the investment?
And most importantly what's the correlation to what I already own. It's giving you more tools to put in your toolbox and a greater expanse of environment to think about building your future portfolio next. Oh yeah, I threw this in here, cuz it is a little bit of a mind bender, portfolio risk calculations, don't mesh well with the psychology of investing.
A lot of this is due to, you're assessing things that are based on standard deviation and standard deviation is a calculation that's based on upward and downward movements. And let's just be honest. If we have an excess return and we have one of our assets that we own has an outperformance on the upside.
Although depending on the nature of the trade, you should understand why it had an outperformance. So don't just blindly accept and, raise your champagne glass, understand why it happened, but we don't really care. We don't view that as a risk. We view that as, okay, great. We got lucky and there was an opportunity there.
So psychologically investors tend to think about. I'm only worried about massive losses. So when you're thinking about some of these calculations in portfolio risk, remember the base calculations it's thinking about an even distribution of both upside and downside. So that's why I threw that in there and think about.
That as you're thinking about diversification also and building your portfolio is that some of these calculations, like I go back to the sharpe ratio it's based on standard deviation. So there are other ratios that have been created to adjust for this, the Treynor ratio and some others.
So some more research for you to do, but that's why I threw it in there. Let's see. Yeah, go ahead. Go back for a second. I wanted to make sure that I covered all my thoughts on this. Yep. I covered everything. Sorry. I'm ahead of myself. So next steps. What are we gonna do now? We know that we should think about these various aspects of diversification within our portfolio, and we might want to consider alternatives. Think about your portfolio construction.
Where is it now? What have you built? And give you an example. A lot of people have a hub and spoke model and it's become a very popular investment model for a lot of wealth managers, a lot of big RIAs when we're looking at more complex clients is I've got a traditional box of long stocks and bonds, and that's got a certain level of diversification amongst itself. And as I think about some of these alternatives, maybe these are the spokes to that wheel. So we've got that centerpiece to our wheel, which is what we all understand what we've done for maybe the last 10, 12 years.
And that's worked very well, but we know we've gotta make some changes. I'm not saying that you should go in and turn everything upside down. This adjustment and advancement into alternatives as part of your portfolio, if you haven't done it yet, may take some time. And I always am a proponent of educate yourself and then step.
Don't step and then educate yourself. You can step on or step off a cliff or step on a landmine, however, whatever analogy you want to use. But then you've got these alternatives or things that you're gonna add to your portfolio that are these spokes, they're smaller percentages of your portfolio.
And they may grow over time or as you become more comfortable, you may increase the allocation to that. But at first you want to build that core, understand your, and then build these spokes in these smaller pieces. And I always tell people, identify what you have a passion for. if you're passionate about understanding real estate or you're passionate about startups, Attack that first go after that, educate yourself about that.
Add that to your portfolio because I'm a firm believer as you're adding spokes to this core portfolio. Those are the ones that are gonna be the easiest to understand. And those are the ones that are gonna be motivated to understand and go educate yourself because you have a passion to do if you have no interest whatsoever in various esoteric hedge fund strategies, it's gonna be hard for you to have the motivation to go educate yourself.
Now one of the things you can do is you can outsource, or if you're working with an RIA that has a platform for alternatives then use that. Use them as that conduit to better understand things that maybe you don't have a passion for. But that's how I always generally believe, Go after what you're excited for.
Cuz then it's easy to learn cuz you have a motivation to learn. You're gonna put in the time and the effort and that's a good start to get started down the alternative path. And then as I say in this, work with your financial advisor if you are really excited about alternatives and that's something you really want to add and your current financial advisor doesn't offer that Maybe they have an association with another group that does, or, or maybe, you outgrow your current financial advisor and you move on and think about, adding alternatives in a different way.
There's a number of clients who've done both. I'm not saying one is better than the other, but there are a variety of things to think about as next steps for yourself as you want to advance this. I know, like I said, with regards to what I work with, and mostly in real estate, there's a lot of networking, a lot of different investment groups.
It doesn't cost to join any of these things you can go in and you can educate yourself and really talk to people who've already made it. And added that to their portfolio, figure out what they did wrong or what has worked for them. And maybe that's another way to accelerate your process into something that you may not have interest in.
And, but, it's important and you're trying to find avenues of how you can appropriately add that to your portfolio. Do we have any Do I have any questions or if we don't I'll just wrap up and we can take some questions afterwards is, what will cover, coming up next.
Now I've given you a highlight of what alternatives are. I've told you, Hey, you should think about further diversification and educate yourself on how to advance diversification and how alternatives. I personally believe, are a great fit for a majority of people's portfolios to help them not go out on the risk curve, but still meet their required returns.
I think that is something that is facing everybody. And then next we're gonna be talking about. Now you're ready to make that follow some of those other steps. And you're gonna go take a look at some private investments and how do I do that? And next we're gonna be talking about due diligence.
So there it's not as simple as pulling up, public research reports on, various stocks or mutual funds or ETFs. There's a lot of other documents you gotta read and understand. It comes in two pieces where we'll talk a little bit about the investment due diligence side of things, understanding the investment.
And how they're making their return. But the other side of it is the operational due diligence side is understanding the company, the managers, what they've built, how that facilitates the operation of the fund and how it protects you as an investor. So we will walk through a number of different investment and operational due diligence aspects in the next talk.
And then after that, as I always like to end with, okay, What specific questions are you gonna ask? So you get in there and you understand the basics of due diligence now, and you're looking at a brand new private fund. What questions do I need to ask so that I can understand what I'm getting myself into and we'll actually supply.
Real questions. That me as a professional, when I used to go in and vet hedge funds and a number of other people I still work with who do that as a job will get real questions and will divulge those questions throughout the entire process of due diligence of what you should be asking.
So you better understand. So I hope you can join us for those events coming up in the next couple months..
Oh, . Yes. You can ignore yeah. This data that was put together by the CAIA and I'm one of the board members for the Pacific Northwest chapter of the chartered alternative investment association. And I wanted to share this information cuz they just put this together recently.
As they're building out a paper called the portfolio of the future. And if anyone's interested in that we have authorization from the CAIA to share that with whoever would like access to that paper. So you can reach out to me or Rachel and will get you and we'll get you access to that paper put out by the CAIA, but I wanted to share this real quick, just You're not listening to just my words.
I hope you enjoyed the time that I was discussing and the topics I was discussing, but sometimes numbers speak louder than words. And so at the bottom part of this chart, they put together what does the traditional 60-40 portfolio look like? And what was the return over the last year?
And all these are ending December 31st, and then they showed five years, 10 years, 15 years. And then they created an alternative asset portfolio. Now I'm not suggesting anybody would go, just go 100% alternative. But they just ran. It should say, Hey, what if we equal weight? All the various subcategories that you can see in the various rows.
What if we equal weighted that? What would that look like? And then lastly, they put together, what can in quotes, the endowment model of where, what we were talking about a little bit about that hub and spoke of where, Hey, I've got, some portion and they made 40% public, 60, 40, so I've got, 40% of it in a 60 40 split between, traditional equities and traditional bonds.
And then I've got 60% in alternatives and there again, they made this equal weighted for that section of the portfolio. And you can see as the end of December 31st, you've got a scenario where you're looking at wait, we did create some excess returns pretty much at almost every level of .
All the way out to 15 years. And most importantly back to the original point of this is not just about return capture, but understanding the risk and creating risk adjusted returns for the 10 and 15 year period. You can see the addition of alternatives actually muted some of the volatility as well and created lower drawdowns for various periods.
Just wanted to throw that to you. That was put together by the research department for the CAIA. And if you want further access to the report and how that was put together I'll ask if we can get approval to send out the base numbers. I know that they've got a lot of agreements with a variety of different organizations that supply this information to 'em.
So we may not be able to get the meat behind it, but this is an important show of numbers. Listen, the addition of alternatives, even blindly across an equal weighted truly did create an impact to someone's portfolio, creating a greater return for less or similar risk. So I think that's a very important point to make and showcase given this conversation.
So thank you again. And Rachel I'll let you close. Yeah.
Rachel: So thank you very much. We wanted to open it up right now for Q and a. So please type your questions into the chat box. It looks like we already have a couple. One did say yes, I would like to access that paper. So I'll get you over the email for that, Chris.
Chris: Yeah. Yeah, definitely. I got Sean's email there. I can send it.
Rachel: Perfect. Another is how do I know if I'm too late to diversify?
Chris: Too late to diversify. I assume you're talking about current events that are going on.
That is a really hard question. I'll give you my answer. If I was managing your money, I would be like, listen, it's never too late to start thinking about diversifying. You've gotta assess what do you think you need to adjust in your portfolio? Obviously, I don't know your portfolio, but it's okay if you were slightly overweight equities, are you still technically overweighted equities given to where you want to be, and this is where your financial advisor can run some models and come up and say, Hey, if my target return is.
10%, whatever it is, where do I need to be? And what do I have access to that can give me those excess returns without taking additional risk. I am a believer that if it's something you need, you think you need to do, you just need to get started. And even if it's a slow gradual process, you're on the right path now to think about diversifying.
I know a lot of people. The "risk on" trade was the way to go. And a lot of people were a hundred percent equities and this year has been unduly painful for them. I think there's an assessment of when did your portfolio start? I did have one person, about a month ago, asked me and said I'm still up on a lot of my equities.
You, what should I do about diversification? I was like, If you're up still and it's something you think you should do then, start pairing back on that, even though it's not at its top, it's not at the high and you're not selling at the top. And I'll just let you know, in 26 years, I think I've sold something at the top, like twice.
And I'll tell you it was pure luck. Selling it at the top and really hitting it is luck. There's very few people who can mathematically understand that it's always gonna be a range around what you want, but in short, start the process, even if it's like, what do I want exposure to? And I need to start educating myself so that when I'm, when, and if we get a move back on this market, the Fed has announced that they have no, no motivation.
To care about the financial markets, their sole goal is to battle inflation. And if they crush the equity market and the process of battling inflation, they don't care. They've made that abundantly clear. They've already announced that there's gonna be two more hikes. And I think, on the back end of the inflation numbers that we just received from May, you're looking at a situation where, okay, so we might have a very muted equity market for the rest of this year.
When does it actually turn around? Your guess is as good as mine. There's a lot of people who will give you a date to that. I will not but at least find what you want to diversify into and then start educating yourself. And if you've already educated yourself about it, then making that decision to move in some gradual movement I think is smart.
Rachel: Okay, thank you. And the last one is how do I know if my investments work well together and I'm truly diversified?
Chris: Yeah. That's well, that's unfortunately down to the math that's where you gotta understand those correlations. And you've gotta run and or have someone that you're working with on your portfolio really run.
What they call stress tests of okay, here's your current portfolio? What if I had this and I ran through this event or historical rising inflation what would generally, at least with the historical view, which, you gotta take with a grain of salt, cuz not every event is the same.
What we're facing right now is. I've heard a lot of people like, oh, are we going into another oh eight? And I'm like, there are so many things that we're about ‘08 that are not happening right now. So we're not in another ‘08. This is gonna be a negative event, but it's not gonna be to the magnitude cuz there's a number of different factors happening.
But how things are gonna work is take a glance of what you own, and then hopefully whoever you're working with can run some kind of stress test and understand there again, those correlations. And I get it. If you're already in alternatives and you've deployed alternatives, that adds a factor of complexity to that calculation.
And there again, hopefully you're working with a financial advisor that can handle that complexity. And understand and be able to assess, is that gonna be a countercyclical investment or is it gonna move in tandem with what you already on, on the traditional side, but there's no simple way to get around.
You gotta run the math and understand, am I really diversified? Cuz what worked 15 years ago, doesn't work today. Given what I was saying earlier, there's so many things that have changed.
Rachel: Alright. Thank you. So I think that's all the questions that I see here. We do have the contact us, so please reach out Chris and I are happy to answer any questions offline as well. We will get the paper over to whoever requested it. And again, if you haven't had a chance to request it yet and you would like to please contact us.
We'd love to. Thank you very much, Chris. And thank you for everyone
Chris: Who thanks everybody. And thanks, Rachel. Yep.
Rachel: Thank you. Take care. Cheers. Bye. Bye.
