These three offbeat investments might be able to make money for you when stocks and bonds don't.
Three advisers walked up to me after I spoke at a recent financial planners' conference. We schmoozed about the usual stuff -- the stock market, interest rates, inflation and so forth -- then we talked about the state of their businesses. The mood turned sour. "We're all ticked off," said one of the advisers, a man I have known and admired for a decade. Actually, those weren't his precise words; I cleaned them up a bit for family consumption. But you get the picture.
Why are they so annoyed? These are hard times for money managers. Most at this conference -- run by the National Association of Personal Financial Advisors, an organization of fee-only planners -- derive the bulk of their income not by charging clients by the hour or by the plan, but by claiming a portion of assets under management, typically on the order of 1%. Thanks to the bear market, "everyone in this room is taking a big pay cut," said the adviser.
The bear market has also left many advisers questioning many of the investing verities that have been drummed into them over the years -- in particular, the long-term performance advantage of stocks and the importance of diversification. The pros are asking whether these things still make sense and whether it's time to look at alternative approaches to money management.
Not coincidentally, "alternative" was one of the buzzwords at the NAPFA meeting. Another was "non-correlated." To be more precise, the conference's exhibit hall was filled with firms promoting non-correlated, alternative investments. In plain English, they were hawking investments that don't move in sync with things like the U.S. stock market and Treasury bonds. Here are some of the alternatives that were featured, along with my impressions:
Managed commodity-futures funds. These products make bets on anything you can purchase a futures contract on -- from pork bellies and wheat to gold and petroleum to interest rates and stock indexes. Because it takes a small amount of cash to control a large amount of a commodity, futures can be very volatile. But representatives of several funds demonstrated that over both short and long periods, managed-futures accounts make money when stocks and bonds don't and can dampen a portfolio's volatility.
Until recently, you needed to invest with a commodities trading adviser (CTA) to get into managed-futures funds. But these products suffer from three big problems. The first is information, or lack thereof. Who can name any of these accounts? The second is high costs. Like hedge funds, commodity-trading accounts typically charge 2% a year and grab 20% of the profits. The third is lack of accessibility. To gain access to a CTA, you generally must be an accredited investor, meaning that you must have a high net worth or earn a big income.
But now, financial firms want to offer commodity-futures strategies to the little guy. Several hedge-fund sponsors now offer commodity-futures funds with modest initial-investment requirements. For example, you can invest in Grant Park Global Alternatives Markets 3, a fund run by experienced teams from different commodity advisers, with as little as $5,000 in a regular account and $1,000 for a retirement account. On the class of shares with those minimums, the break-even level (similar to a mutual fund's expense ratio) is 5.72%. Clearly, that's on the high side. You'll have to decide for yourself whether the price is right.
A better choice may be Rydex Managed Futures Strategy (symbol RYMFX), a regular mutual fund that seeks to match the daily performance of the Standard & Poor's Diversified Trends Indicator, which invests 50% in commodity futures and 50% in financial futures. The fund, which requires $25,000 to start, charges a relatively modest 1.88% a year and a 1% redemption fee if you sell within 30 days of purchase.
Futures accounts held up reasonably well last year. The Barclay CTA index, a measure of performance of commodity trading advisers, gained 14% in 2008 -- a year when the S&P 500 plunged 37%. I predict that in coming years the managed-futures category will expand dramatically.
Farmland. For some time I've been searching for a vehicle that gives investors ownership shares of productive farmland. These are popular in Canada, but in the U.S I've seen only private deals that require at least $1 million and are confined to a general partner's home state. So I was delighted to learn that I had overlooked a small operation from Iowa called Agrinuity.
Glenn Kreuder, the principal, explained to me that if you fork over the initial $100,000 minimum, you get title to Iowa farmland leased to working farmers. For that amount, you can purchase 20 acres of land that you can sell at any time. The acreage should generate annual rent of about $5,000 (less taxes and insurance of about 0.25%). So, you could earn a cash-on-cash yield of nearly 5%, with potential for appreciation and higher rents when the farmers renew their leases. And there's been plenty of appreciation in Iowa farmland. Prices have climbed from $787 an acre in 1986 to $4,500 in 2008, an annualized gain of roughly 8%.
Still, there are no sure things. Prices are expected to drop this year, and it's worth remembering that Iowa farmland was worth $2,100 an acre in 1981, meaning it took a big hit over the following five years. But for most of that period, stocks were soaring, so you can argue that farmland really is a great portfolio diversifier.
"Unconstrained" funds. These are mutual funds, limited partnerships and other vehicles that can do whatever they darn well please. They may invest in foreclosed shopping strips and apartment complexes, various kinds of loans, and even storage containers.
Representatives of one sponsor, Pacific West Land, showed me a deal in which one of its funds paid $140,000 for a delinquent subprime land loan that had a face value of $975,000 and was due in three years. Pacific restructured the loan by slashing the interest rate to 5.5%, improving the likelihood that the borrower would be able to repay the principal at maturity. For this fund, Pacific is raising $30 million in $100,000 units, but its minimum for other deals is as low as $50,000.
All kinds of sponsors are -- or will be -- chasing after such distressed or unwanted assets. The deals are risky, but you won't lose 8% in a single day because an analyst cuts a stock's rating from buy to hold.
To tie this all together, I consulted Ron Albahary, of Schroders Investment Management, one of the nation's top strategists about portfolio diversification. Albahary says he's already met more than 5,000 financial planners and advisers this year, and at the top of their minds is this question: What do I do differently in light of the miserable failure last year of the traditional strategy of putting 60% in stocks and 40% in bonds?
Albahary's answer: Forget allocating among stocks, bonds, cash and other stuff. Think instead in terms of low-risk, high-risk and "opportunistic" investments. Then set your percentages on the basis of your time horizon, needs and personality. Maybe you want 60% in low-risk investments (high-quality, short-term bonds, Ginnie Mae mortgage bonds and CDs), 30% in high-risk securities (stocks and real estate) and 10% in opportunistic ventures, defined as whatever is extraordinarily cheap and out of favor. Although that could be stocks, it doesn't have to be; it could also be a managed futures fund or a piece of Iowa farmland. "We've become way too equity-centric as a society," Albahary says, suggesting that fear of falling stock prices all too often paralyzes investors.
The investment industry usually creates what will sell. Sometimes that's a good thing; other times, it's not so good. Nowadays, with both individuals and advisers clamoring for investments that don't move in lock step with either stocks or bonds, a broader array of choices is good. The next time stocks plunge, you'll be thankful for the opportunity to own some farmland or coffee futures.