I get a big kick out of the alternative uniforms that professional sports teams wear sometimes, especially throwback uniforms. The picture in the header of this post is a powder blue throwback from the Cardinals. Baseballcard Twitter loves these uniforms and so do I. The Phillies also wear them occasionally and of course the Washington Nationals wore them when they dressed out in Expos uniforms in mid-July.
As big of a fan as I am of these alternative uniforms, I also find a lot of utility in using alternative strategies in client portfolios as a way to help manage volatility.
Ben Carlson had a quick write up on alternatives including a table noting not just that they've trailed behind equities which he says is to be expected but also have trailed behind a 60/40 portfolio which Ben observed with some surprise.
Alternative strategies include things like gold, other commodities, long/short, managed futures, volatility, absolute return, certain options strategies, even hedge funds and private equity can be thought of as alternatives. Bitcoin could also be thought of as an alternative. For now Bitcoin has no correlation to anything so it seems but of course it's volatility is off the charts. It would not be a surprise if someone allocating 2% to Bitcoin today wound up adding thousands of basis points in performance over the next ten years just as it would not be a surprise if it wiped out, detracting the full 200 basis point allocation.
I discovered and starting using alternatives before the financial crisis and continue to be a big believer, but it need to be understood, a big believer in small doses.
Gold for example tends to have a low to negative correlation to equities the vast majority of the time. In that light, it makes no sense to expect gold to keep up with equities in a raging bull market and of course it has lagged badly but maintained its low to negative correlation...the vast majority of the time. The SPDR Gold Trust (GLD) which is a client and personal holding is up 15% in the last three months while the S&P 500 is down 1.7% per Yahoo Finance. Earlier in the spring when equities were doing very well, GLD was down a little. And back in December when the S&P 500 was down 20-ish%, GLD was up mid-single digits. Anything could happen in the future with this relationship but it works often enough for me to stick with it as a diversifier.
The other alternatives I use are similarly reliable, no guarantee about the next go around but they've worked often enough that I believe they will work in the future. Of course any given strategy may not work the next time I need it to which is the argument for using several of them in small doses.
As part of getting defensive, I will increase exposure to alternatives as a means to de-equitize the portfolio. So then the hope would be that after the market goes down a lot that I would start to re-equitize the portfolio. It is possible to do this without doing a lot of selling and then buying of equities as opposed to adding and then removing alternatives. What you'd be doing there is adding and removing strategies with negative correlations to equities. If you add a bunch of negative correlation exposure, and the negative correlation persists, then you would have neutralized your long equity exposure. This would be ideal if you can do it.
If you doubt your ability to get in after a large decline, set a parameter right now while the market is near its high and just had an up day. How about, if the market drops 30% you will buy more, or at least re-equitize, knowing that you won't likely catch the bottom, you'll just be buying cheaper, a lot cheaper. Selling/reducing kind of high and buying/adding kind of low is a great way to go and as hard as it might be, it will be easier if you define parameters for both, well ahead of time.