Nirvana

With stocks displaying tremendous volatility and with bonds yielding next to nothing, it is no wonder that investors are looking for a state of perfect happiness beyond these traditional asset classes.

In 1991, the grunge rock band Nirvana made alternative music mainstream with their album Nevermind.  Today, in the world of investments, alternative asset classes are becoming conventional.  When the esoteric enters the mainstream, like alternative music topping the pop charts, you have an oxymoron.  When this happens in the world of economics, you have a problem.

Take home ownership as an example.  In October of 2004, President George W. Bush was publically celebrating a new era of prosperity, in which nearly every American had the opportunity for home ownership: “We’re creating… an ownership society in this country, where more Americans than ever will be able to open up their door where they live and say, welcome to my house, welcome to my piece of property . . .”

You may remember seeing neighbors and wondering how that person could afford their house.  But, unsustainable trends like the U.S. housing bubble only become crystal clear through hindsight.

Few people, including the President of the United States, who has access to vast quantities of information and an army of experts, saw disaster on the horizon.  Rather, the vast majority of Americans, including the President, thought more widespread homeownership was a panacea.

In 2000, David Swensen, the Chief Investment Officer of the Yale University Endowment, published the book, Pioneering Portfolio Management:  An Unconventional Approach to Institutional Investment.  At the time, Swensen had already been transitioning Yale’s portfolio toward alternative assets – real estate, timber, hedge funds, non-dollar-denominated securities, etc. – for nearly 15 years.

As such, Swensen was a pioneer; he was ahead of his time.  His strategy of allocating the vast majority of Yale’s endowment to alternatives continued to work all the way to 2008.

But now, everyone from retail stock brokers to bank trust departments are pushing alternative strategies, sometimes utilizing expensive mutual fund products or exchange-traded funds to mimic Swensen – albeit twenty-six years later.

Just the other day our office received a package advertising the Nationwide Alternatives Allocation Fund.  The fund’s intent is to “provide investors with exposure to several categories of alternative investments with investment performance that may have a low correlation to the performance of more traditional investments (i.e., stocks of U.S. and international developed-country issuers and investment-grade bonds issued in the U.S.).”  A division of Nationwide Insurance distributes the product, but Goldman Sachs Asset Management, L.P. manages the investments.

Interestingly, just last month Goldman Sachs announced it would close its most high profile hedge fund, Global Alpha.  In other words, Goldman’s super-rich Global Alpha clients are getting refunds while Nationwide’s retail investors are being aggressively marketed another Goldman-run vehicle.  Theoretically, high net worth clients are perceived to be more sophisticated than the average retail investor, making this the kind of anecdotal contrarian sign for which we need to be attuned.

The natural human inclination in investing is to look at recent trends and project the same conditions into the next ten years.  This is nearly always wrong.

Thirteen years ago, in 1998, newsletter writer and best-selling author Harry S. Dent, Jr. penned the book, The Roaring 2000s: Building the Wealth and Lifestyle You Desire in the Greatest Boom in History.  As it turned out, the decade of the 2000s let out a whimper rather than a roar.  But, a booming stock market was the most recent trend when Dent wrote the book in 1998.  Perhaps foreshadowing another untimely prediction based on recent events, Dent’s newest effort, published just last month, is entitled, The Great Crash Ahead: Strategies for a World Turned Upside Down.  And believe it or not, even Harry has gotten into the alternative investment game, promoting his own alternative exchange-traded fund since September 2009 called the Dent Tactical ETF.

And we believe we are seeing yet another development that nobody predicted.  Coming into 2011, strategist were nearly universal in their opinion that emerging market stocks would thrive and that U.S. multinationals would likewise benefit from their exposure to emerging market growth.  “BRIC” countries, i.e. Brazil, Russia, India and China, were the place to go for gains.

Well, year to date, Bespoke Investment Group finds that U.S. companies that get more than half of their revenue domestically have drastically outperformed their Standard and Poor’s 500 brethren who get more than half of their revenue internationally.

Furthermore, the alternative investment that looked invincible until about a month ago was gold.  On August 19th, 2011, the most popular gold exchange-traded fund (GLD) surpassed the largest S&P 500 exchange-traded index fund (SPY) in value.  Since then, even gold has tumbled.

Many of the hedge fund managers who invented the alternative investment category have recently hung up their spurs, citing outsized stress and a lack of investment opportunity.  Stanley Druckenmiller closed Duquesne Capital in 2010 after 29 years, George Soros in July of this year returned investors’ money after 41 years and Carl Icahn followed a similar path in 2011 after 43 years.

These retirements present a dichotomy in the world of alternative investments.  The innovators are getting out and the imitators are getting in.