Historically, access to asset classes and investment strategies outside of stocks and bonds has been limited for many investors, with concerns such as high minimum investment requirements and a lack of liquidity acting as barriers to entry. Fortunately, financial innovation and the proliferation in exchange-traded funds (ETFs) over the past 20 years means that many strategies and asset classes that were either out of reach or off-limits are now widely available in a liquid, transparent and tax efficient wrapper. For example, commodities in the energy, agriculture, industrial metals, and precious metals spaces are all available via ETFs that own commodities futures. Hedge-fund style strategies such as global macro, managed futures, merger arbitrage, and long/short equity are available in liquid, low-cost ETFs. Leveraged and inverse ETFs are available. Defined outcome strategies that use derivatives contracts are available. ETF “fund-of-funds” that focus on private credit and private equity are available, as are managed futures strategies (CTA’s). Additionally, as of January this year, even bitcoin can now be owned via an ETF in most brokerage accounts.
The widespread availability and accessibility of these strategies and asset classes, commonly referred to as “alternatives,” gives investors additional tools with which to enhance and diversify balanced portfolios. The traditional stock-and-bond-only 60/40 model, we believe, is limiting. Stock-and-bond-only portfolios miss out on the strong return potential and diversification benefits that come with owning alternatives. We believe that a small, dedicated allocation to liquid alternatives should be considered foundational to a well-diversified portfolio. Our CST multi-asset class portfolios currently have a 2% strategic allocation to alternatives.
With that said, considering the diverse nature and goals of the assets and strategies that fall under the umbrella term “alternatives”, it is very important to be selective. Please read on for details about our favored alternatives in the current investment environment and their strategic allocation within our multi-asset class models.
1. Diversified Commodities
Commodities have low correlations to traditional asset classes and have historically acted as an excellent hedge against inflation. Commodities are “real assets” that react to changing supply and demand fundamentals in different ways than stocks and bonds. The supply and demand for commodities is affected by factors such as capex within commodity industries, geopolitics, and regulation/policy. While stock prices are primarily determined by discounting expected cash flows stretching far into the future, commodities must clear in the spot market, meaning that the price of commodities futures reflects short-term supply and demand dynamics.
As evidenced by the recent strong US Consumer Price Index (CPI) print of 3.3% YoY for Q1 2024, the fight against inflation is far from complete, especially given the current backdrop of above-trend growth and heightened geopolitical risk. As such, we believe that commodities’ intrinsic exposure to inflation provides purchasing power protection. We also see long-term prospects for commodities given the chronic undersupply in the market. A lack of investment in recent years combined with policy efforts to address climate change and re-shore supply chains are likely to be supportive for commodities as an asset class from a secular perspective.
Our preferred vehicle for commodity exposure is Invesco’s Optimum Yield Diversified Commodity ETF (ticker PDBC). This provides diversified exposure to a basket of commodities including approximately 58% energy commodities (such as crude oil, gasoline, heating oil and natural gas), 17% agricultural commodities, 14% base metals and 11% precious metals.
After waiting to see the price momentum move into an uptrend, we added a 1% allocation to PDBC in our multi-asset class models in mid-March.
2. Managed Futures
Managed futures managers, known as Commodity Trading Advisors (CTAs), develop sophisticated quantitative models and algorithms to analyze market data and identify trading opportunities. These models often incorporate factors such as price trends, volatility patterns, and market sentiment indicators to make trading decisions. Managed futures strategies have a strong track record of delivering positive alpha with very low correlations to equities.
We think that managed futures are an excellent diversifier of traditional market risks in today’s environment given their ability to follow trends, both positive and negative, which provides potential for positive absolute returns, even in a market downturn.
Our preferred investment vehicle for managed futures is Simply Managed Futures Strategy ETF (ticker CTA). It provides a systematic long/short managed futures strategy designed for absolute return and portfolio diversification. It employs four underlying systematic models including a price trend strategy, mean reversion strategy, carry strategy, and risk-off strategy. CTA does not hold equity futures, thus reducing its correlation to equity market beta. CTA holds a 0.5% allocation in our multi-asset class portfolios.
3. Digital Assets
In early January, the SEC approved the first spot bitcoin ETFs, giving investors the ability to hold bitcoin in traditional brokerage accounts for the first time. Bitcoin ETFs allow investors to side-step the complexities that come with buying crypto directly through crypto exchanges and owning crypto directly in crypto wallets. It marks a key moment in the maturity of the asset class and is encouraging mainstream adoption.
Bitcoin tends to polarize opinion. Crypto-bulls believe that Bitcoin is a groundbreaking technological innovation with the potential to disrupt traditional financial systems and revolutionize various industries. Additionally, bulls argue that Bitcoin provides a hedge against the devaluation of fiat currencies, particularly times when governments and central banks engage in expansionary policy. Bitcoin is often compared to gold in that it is a store of value that is not subject to government manipulation or inflationary pressures (the supply of Bitcoin is capped at 21 million coins).
Crypto-bears on the other hand, question bitcoin’s value given there are no cash flows associated with owning it and, despite its decade-long existence, it has yet to achieve widespread adoption as a medium of exchange or store of value outside of speculative trading.
But whether you are a bull or a bear, bitcoin’s utility from a portfolio construction perspective is indisputable. Bitcoin is volatile but has extremely low correlations to other assets. From a total portfolio perspective, this risky investment actually contributes to the creation of a safer portfolio. The important caveat here is that this investment must be sized appropriately. Our CST multi-asset class model portfolios hold only a 0.5% allocation to HODL, Van Eck’s Bitcoin ETF.
Conclusion
Alternative investments help diversify portfolios from the economic, earnings and interest rate risks that are present in stocks and bonds. Commodities, managed futures and bitcoin in particular, are three investments that can be owned easily and cheaply, and we believe will provide the best upside in today’s environment while maintaining low correlations to stocks and bonds. Especially in today’s climate of higher-for-longer inflation and interest rates, we believe that the inflation protection that these investments provide will help deliver superior risk-adjusted returns.
Disclosures: This information was produced by, and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however Accuvest does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold, or recommended for client accounts.
The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and they may be significantly different than those shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.