Alternative Investment Myths: Volatility And Lock-Ups

On Alternative Investment Myths by David Merkel, CFA of AlephBlog 

I think alternative investments should analyzed the same way that ordinary investments are analyzed.  After all, I have written: On Alternative Investments and Alternative Investments, Illiquidity, and Endowment Management.  So when I read an article like this one at Militello Capital (not to pick on them, but I read it there), I say that I agree with points 1-4, and disagree with points 5-6.  What are points 5 and 6?

5. Alternative investments are more volatile than stocks and bonds.

As a whole, private alternative investments tend to be less volatile than the stock market. Why?  Because investors tend to view alternatives as long term investments, and cannot constantly trade in and out of them.  In this day and age of high frequency trading and quantitative arbitrage (by the way, do most investors even know what this even means?), it is refreshing to know that long term investments still exist.  According to 10 Myths Surrounding Alternative Investments by Nancy Everett and Mark Taborsky of BlackRock, “Adding alternatives to a diversified portfolio has the potential to provide lower volatility than a portfolio composed exclusively of traditional stocks and bonds.”

6. Investors cannot access their capital if invested in alternatives.

As with most stereotypes, this one does not always apply. Yes, many alternatives are less liquid than traditional investments but the level of liquidity is dependent on the investment itself. Everett and Taborsky agree by stating “As with all aspects of investing, there is a tradeoff between risk and expected return and liquidity is no different. When investing in less liquid assets investors should, of course, expect to be compensated for that illiquidity through improved risk-adjusted returns.” Alternatives that are illiquid also allow individuals to invest in tangible assets. Investments you can talk to.  Investments you can visit.  When’s the last time you visited your hedge-fund?

As for point 5, anything that you measure over longer time horizons will have lower annualized volatility than what is measured over short horizons.  Whether a business is public or private does not affect the underlying volatility of the economics, though it may affect the accounting.

As for point 6, there are far more limitations in accessing capital from alternative investments than from ordinary investments.  Alternatives are not as liquid, except when times are bullish.  The same is true of condomiums, which indeed are fungible, but are rarely liquid, with a tight bid/ask spread.

As such, I don’t think points 5 & 6 are myths.   They are the truth, those that argue against them are proposing myths.

Alternative Investment Myths: Volatility And Lock-Ups
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