SAN FRANCISCO (MarketWatch)—The rich are different from you and me, except when it comes to the types of investments they make.
Sure, the wealthy have more zeros in their accounts and access to top financial advice, but the sophisticated capital preservation, hedging and portfolio-diversification strategies once available only to the country-club set are now available to the country at large.
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Moreover, nowadays you can get the investing equivalent of a chauffeur-driven Cadillac for the price of a Camry. Many specialized boutique firms have branched beyond their high-net-worth bread-and-butter and offer their expertise to the retail public through relatively inexpensive, easily traded mutual funds and exchange-traded funds.
“A lot of options are opening up for the ordinary investor to really take control,” said Kevin Cimring, co-founder of Jemstep, an online investment-advice provider.” It puts them in a position that is closer to the advice wealthy investors take advantage of.”
Actually, rich investors are different in two important respects that ordinary investors can learn from: knowledge and strength. Their portfolio decisions typically are better-informed and they have sufficient diversification to hang tough in rough markets.
High-net-worth investors “understand the trade-off between risk and return,” said Kurt Silberstein, managing director of alternative investments at Ascent Private Capital Management, a division of U.S. Bank. “They have staying power and conviction in their investments.”
Risk and reward
Investing like those protected by deeper pockets can be risky, but blending a small amount of exotic holdings with traditional core holdings of stocks, bonds and cash in fact lowers a portfolio’s volatility, because alternative assets don’t move in lock-step with stocks and bonds. They’re even independent of precious metals, commodities and currencies.
In this way, investors get a smoother ride down Wall Street over time, and a cushion from the uncertainty of the U.S. “fiscal cliff,” euro-zone woes or whatever geopolitical challenges face the world.
“Look beyond stocks and bonds, and see what other options are available to enhance portfolio return,” said Jim Baird, chief investment strategist at Plante Moran Financial Advisors in Kalamazoo, Mich. “That’s where these types of strategies can come into play.”
Just realize that alternative investments won’t necessarily keep pace with stocks in runaway years such as this, where the Standard & Poor’s 500-stock index
SPX -0.05% has gained around 18% so far. By comparison, for example, long-short equity mutual funds, which in addition to capturing upside also try to profit when stock prices fall, are up just 5%, according to investment researcher Morningstar Inc.
How do you fit alternative investments into your portfolio? For starters, if you have a financial adviser, learn about the types of assets being considered and how their characteristics could affect your portfolio, said William Koehler, CEO of Tower Wealth Managers in Prairie Village, Kan. And ask about cost. Some products come with high price tags; you can certainly find quality “mainstream” alternatives at a reasonable price.
“Most retail investors don’t need these more esoteric products,” especially ones that use leverage, said King Lip, chief investment officer at Baker Ave, an investment manager in San Francisco. “Capital preservation is the key. The rich have come to that conclusion and are staying diversified, protecting the downside; you don’t need to take a lot of risk to have investment success.”
Here are three invest-like-the-rich strategies to consider:
1. Long-Short Equity
Investors in long-short equity funds gain a responsiveness to market conditions that in the right hands can be highly effective. This year so far, most hedged long-short strategies are running far behind the stock-market averages. Still, returns are positive and these funds carry measurably less risk than the market overall.
“If we’re in a low-growth, high volatility market, that’s a bad environment to be long equities,” said Nadia Papagiannis, Morningstar’s director of alternative fund research. “Long-short protects against the downside. You need a manager who can short or hedge equity exposure. ”
Her favorite long-short investments include Wasatch Long/Short Fund
FMLSX -0.14% , which she said buys and sells according to a stock’s fundamentals; Schooner Fund
SCNAX -0.12% , which focuses on dividend stocks and options, and Marketfield Fund
MFLDX -0.25% , which has a top-down approach to its stock-picking.
2. Managed Futures
Managed futures funds invest in myriad futures contracts tied to commodities, equities, bonds and other tradable assets. But these funds march to their own beat.
“They’re not correlated to stocks or bonds and have the potential for equity-like returns,” Papagiannis said. “They don’t need growth in the economy; they need price trends.”
Indeed, these portfolios do best when there’s a persistent market trend in either direction, added Jeff Layman, chief investment officer at BKD Wealth Advisors in Springfield, Mo. The worst environment is a range-bound market or one with a quick, sharp move, he noted.
“It’s one of the few areas where you can potentially be profitable when the market moves up or down,” said Layman, who uses AQR Managed Futures Strategy Fund
AQMIX -0.10% for clients. The fund’s performance is essentially flat for the year so far—much better than the category’s almost-5% average loss.
3. Market-Neutral
Market-neutral strategies match long- and short stock positions in an effort to neutralize most or all market volatility. The tactic succeeds when a manager generates excess return adjusted for the fund’s risk level, known in portfolio-speak as “alpha.”
So far this year the market-neutral fund category has gained only 1.4% on average, but many of these funds have done their job and delivered positive alpha, according to Papagiannis. One of her favorites is J.P. Morgan Research Market Neutral Fund
JMNAX -0.14% , which has gained about 4% so far in 2012.
Another recommendation, IQ Alpha Hedge Strategy Fund
IQHIX 0.00% , isn’t a pure market-neutral product but includes the strategy along with several hedge-fund disciplines including arbitrage and global macro. It’s up close to 5% this year.
Said Papagiannis: “A combination of long-short equity, managed futures and market neutral would be a good combo.”
Jonathan Burton is MarketWatch's money and investing editor, based in San Francisco.
