Investment Consult

You need more than stocks

To help your portfolio through rocky market times, consider these alternative investments.

Lewis J. Altfest, PhD, CFA, CFP

Nervous about your nest egg? If it's loaded with stocks, you should be. Stocks could easily sink further, tread water, or rise slowly. To minimize the damage to your portfolio, you need some holdings that don't move in tandem with equities. The most obvious vehicle is bonds, but you can further protect yourself against market swings by including other alternatives, such as hedge funds, real estate, and oil and gas.

Each of these has its own risks, and you'll generally get higher returns if you invest through private partnerships. But partnerships usually require you to make large initial outlays and remain invested for perhaps a year or more. You can get around those drawbacks by opting for publicly traded mutual funds that employ similar investment strategies. That way, you get a piece of the action for a much smaller sum, plus the option to bail whenever you want to.

Hedge funds don't limit themselves to buying securities, and that flexibility improves their odds of profiting regardless of the market environment. The trade-off is that many employ risky strategies, including program trading, short selling, currency and interest-rate swaps, and arbitrage. Investing a small amount through a publicly traded mutual fund that uses some of these strategies is the best way to minimize your risk. Two basic types that are popular are long-short funds and event-driven funds.

Long-short hedge funds buy securities and benefit when they rise, but also sell them short, profiting when they go down. One with a good recent record, AXA Rosenberg Select Sectors Market Neutral Fund—Institutional Shares (800-447-3332), gained 17 percent in the third quarter of 2001, a rocky period for stocks in the wake of the terrorist attacks. But this no-load fund performed well before Sept. 11, too: Its one-year return, an impressive 11 percent, is more than 23 percentage points better than that of the S&P 500.* The minimum investment for the funds' institutional shares is $1 million, but for its investor shares, which provide similar returns, it's just $2,500.

The managers of event-driven hedge funds wait for certain developments before they invest their clients' money. For example, before buying a stock, a fund focused on mergers looks for signs that the issuing company is likely to be gobbled up, such as a deal that has been announced but not yet completed.

One such fund that I like is Merger Fund (800-343-8959), launched in 1989. This fund charges low expenses and has never had a negative return for any calendar year. Although it returned just 2 percent over the past 12 months, in 2000 it returned 18 percent, and over the 10 years through Nov. 30 it delivered an annualized average of 10.8 percent.

Real estate provides a good hedge against inflation and greater current yield than the typical stock. An excellent choice is Cohen & Steers Realty Shares (800-437-9912), a no-load mutual fund that invests primarily in real estate investment trusts—publicly traded companies that own or manage apartment buildings, nursing homes, shopping malls, office parks, and the like.

REITs and real estate funds tend to move opposite to the broader stock market. Cohen & Steers Realty Shares' 5.7 percent one-year return, for instance, beat the S&P 500's return by almost 18 percentage points. The fund's three-year annualized return of 11 percent is 12 points higher than the S&P 500's.

Oil and gas prices could rise if Mideast uncertainties grow in the aftermath of Sept. 11. That would benefit investors in private oil and gas partnerships. In fact, over long periods, these partnerships could return more than stocks. Several of my clients have invested in them with considerable success.

If you can't afford a hefty up-front investment, though, I recommend buying shares of Vanguard Energy Fund (800-662-7447). This no-load fund charges a pittance in expenses and has returned an average of 12 percent a year over the 10 years through Nov. 30. It owns a nice cross-section of energy companies, particularly large oil firms.

Veteran manager Ernst von Metzsch prefers global powerhouses such as ChevronTexaco, ExxonMobil, and Phillips Petroleum, because they can better weather movements in crude-oil prices. This preference, combined with von Metzsch's eye for value stocks—those selling at low prices relative to the issuing companies' apparent value—has helped Vanguard Energy stay considerably less volatile than its peers.

If you choose to invest in any of these alternatives through private partnerships, be aware that those are subject to far less regulation than publicly traded mutual funds. In addition, performance figures can be hard to obtain, and profits are often taxed at ordinary income rates, not the lower capital gains rates.

To minimize these drawbacks, shop carefully and consider getting help from a fee-only financial planner, who won't have a monetary incentive to recommend one type of investment over another. Make sure the manager of any partnership you're considering is honest and capable. You or your planner should check his reputation with investors who've had at least three years' experience with him. If everything checks out, you can be rewarded with attractive performance.

*Unless otherwise noted, all performance figures are through Dec. 31.

The author, a fee-only financial planner, is president of L.J. Altfest & Co.(www.altfest.com ), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

 

Lewis Altfest. Investment Consult : You need more than stocks. Medical Economics 2002;2:18.