That time-worn platitude might explain the growing embrace of so-called alternative investments, a category that includes hedge funds, inverse and leveraged exchange-traded funds, private equity, commodities, futures, floating-rate and private loans, structured products and a whole lot more.
According to a study from the consulting firm McKinsey & Company, retail alternative funds (those marketed to individual investors) accounted for 7% of all U.S. fund assets under management in 2011, up from 3% in 2005. Globally, that number is 10%, up from 8% over that same period. Worldwide, alternative investment assets grew by 14.2% annually over those seven years, compared with just 1.9% for non-alternatives. McKinsey projects that by 2015, alternative investments marketed to retail investors will compose 25% of industry revenues and more than 50% of revenue growth.
Is this offbeat trend a healthy one? Certainly, proper diversification can damp volatility, but that assumes that the investments are worthwhile and exhibit low or negative correlations. In some cases, and for many individual investors, the alternative investment asset class is a solution in search of a problem. And a potentially dangerous one at that.
The Financial Industry Regulatory Authority (FINRA), an independent regulator of securities firms, has warned investors to understand what they’re buying before diving into the alternative pool. A sad litany of fraud cases among alternative products recently was chronicled in a troubling The New York Times story. A whitepaper on the subject by attorneys Seth E. Lipner and J. Boyd Page also provides cautionary advice.
It would be regrettable if equity investors turned away from owning financially strong, fast-growing companies to cast their nets in uncharted or treacherous waters. Yes, most stocks have been trapped in a secular bear market since the dot-com bubble burst in early 2000. But the ongoing cyclical bull market in equities has been powerful and profitable; over the four years through February, the S&P 500 index was up roughly 120%. Many individual stocks have done even better.
For equity investors employing a proven long-term strategy, there is scant reason to shop elsewhere. Stay the course.