By Tom Bradley

I had a coffee with a retired financial executive last month. We were talking about Steadyhand and he asked if we did ‘alternatives’. He said he didn’t want conventional bonds and stocks.

In the July 4th Financial Times, one of my favourite writers, Gillian Tett, made the following comment: “… Millennials do not like relying on financial advisers; nor do they trust bond and stock markets … Instead, the young rich are increasingly putting funds into alternative investment areas, such as private equity or hedge funds, and investing directly themselves.”

And, I recently saw that U.S. foundations have between 30% and 50% of their assets invested in alternatives (depending on the type of foundation). This includes investments in hedge funds, private equity, real estate, commodities including energy and timber, and ‘distressed’, ‘emerging’ and ‘leveraged’ everything.

Hmmm. What’s going on here? What about good old stocks and bonds? Haven’t their returns been pretty good? Certainly the results from many exotic products and asset classes have been mixed, while fees are high and liquidity is low.

Of course, we do know why this trend is happening. Modest return expectations due to near-zero interest rates and rising stock markets have prompted investors to look elsewhere for a magic bullet. They don’t like the yield on conventional bonds and the volatility of stocks.

Now, I have no problem with diversification and taking advantage of different return streams, but to have 40% or more of your portfolio in expensive, illiquid and complex products is pushing it. These portfolios bring two new risks into play, namely ‘complexity’ risk and ‘compensation’ or ‘conflict of interest’ risk. Unfortunately, these two have no upside to them, unlike the basic four risks that fuel long-term returns – interest rate, credit, equity and illiquidity risk.

Lori and I have money invested with a few alternative funds for reasons of education, friendship and history, but most of our performance comes from the most reliable source of return we have – consistent exposure to the bond and stock markets.

Postscript: The retired executive admitted to me that his current advisor had him invest in a series of structured notes and “they didn’t quite play out the way I wanted …”