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The Only Guide to Alternative Investments You'll Ever Need
The Good, the Flawed, the Bad, and the Ugly
Larry Swedroe
Jared Kizer
Invest Outside the Box
Format: Hardcover
ISBN: 9781576603109
Publisher: Bloomberg Press
Pub. Date: 11/2008
320 pages, 6" x 9"
Retail Price: $25.95
Your Price: $22.06
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The rewards of carefully chosen alternative investments can be great. But many investors don’t know enough about unfamiliar investments to make wise choices. For that reason, financial advisers Larry Swedroe and Jared Kizer designed this book to bring investors up to speed on the twenty most popular alternative investments:
--Real estate --Inflation-protected securities --Commodities --International equities --Fixed annuities --Stable-value funds --High-yield (junk) bonds --Private equity (venture capital) --Covered calls --Socially responsible mutual funds --Precious metals equities --Preferred stocks --Convertible bonds --Emerging market bonds --Hedge funds --Leveraged buyouts --Variable annuities --Equity-indexed annuities --Structured investment products --Leveraged funds
The authors describe how the investments work, the pros and cons of each, which to consider, which to avoid, and how to get started. Swedroe and Kizer evaluate each investment in terms of:
--Expected returns
--Volatility
--Distribution of returns
--Diversification potential
--Fees
--Trading and operating expenses
--Liquidity
--Tax efficiency
--Account location
--Role in an asset-allocation program
Any investor who is considering or just curious about investment opportunities outside the traditional world of stocks, bonds, and bank certificates of deposit would be well-advised to read this book.
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Larry E. Swedroe is a principal and the director of research for Buckingham Asset Management, LLC (www.bamservices.com). He is the author of Wise Investing Made Simple, The Only Guide to a Winning Investment Strategy You’ll Ever Need, What Wall Street Doesn’t Want You to Know, Rational Investing in Irrational Times, and The Successful Investor Today. He also coauthored The Only Guide to a Winning Bond Strategy You’ll Ever Need. Swedroe has an MBA in finance from New York University.
Jared Kizer, CFA, previously worked as an investment adviser for Buckingham Asset Management, LLC, and authored this book with Larry while he worked there. He has published articles on investing in the Journal of Portfolio Management, Journal of Indexes, and for indexuniverse.com. Kizer has a master’s degree in finance from Washington University in St. Louis.
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“A timely and valuable book. The authors describe twenty alternatives to investing in traditional U.S. stocks and bonds, and how they work. They tell you which ones to walk away from, which to consider (carefully!), and how to get involved. These are good-sense judgments that every investor should pay attention to.”
—Jane Bryant Quinn
Author, Smart and Simple Financial Strategies for Busy People
“Larry Swedroe and Jared Kizer have written a different sort of investment book, and one that has been sorely needed: a comprehensive guide to the theory, peer-reviewed literature, and practical nitty-gritty of actually deploying portfolio assets. It is a gold mine for even the most experienced of practitioners, and a vital lifeline for small investors. This volume is destined to become the most marked and Post-it–noted tome on the average investment shelf.”
—William Bernstein
Author, The Intelligent Asset Allocator and The Four Pillars of Investing
“What’s missing in your library? Larry’s new Alternative Investments! You’ve already got tons of books on stocks, bonds, and funds. The Only Guide to Alternative Investments You’ll Ever Need is all about the future of investing, the new stuff that’ll give you an edge in the twenty-first century. An absolute must-read!”
—Paul B. Farrell, JD, PhD
Columnist, DowJones-MarketWatch
Author, The Millionaire Code, The Winning Portfolio, and The Lazy Person’s Guide to Investing
“Swedroe and Kizer provide a thorough analysis of the pros and cons of each alternative investment. They recommend ‘good’ alternatives to add to a diversified portfolio of high-grade bonds and stocks. Perhaps more important, they warn investors about the dangers of truly ‘bad’ and ‘ugly’ alternatives."
—Dr. William Reichenstein, CFA
Pat and Thomas R. Powers Chair in Investment Management, Hankamer School of Business, Baylor University
“Swedroe and Kizer have sorted through the clutter and confusion of alternative investments to provide the authoritative voice on these much hyped and frequently misunderstood financial products. Kudos to them for sharing their wisdom in a manner that can be easily understood by all.”
—Bill Schultheis
Author, The Coffeehouse Investor
“What a great service this book is to the investing community! As investors reach out for higher returns, many will venture into the higher-risk category known as alternative investments. For those who are so tempted, this book provides an invaluable guide.”
—Edward R. Wolfe, PhD
Professor of Finance and Director of the Financial Planning Program, Western Kentucky University
“At the risk of being clichéd, Swedroe has done it again! I make it a point to read every book written by him. This time, it’s all about alternative investments, and Swedroe, running true to form, tells it exactly as it is. He pulls no punches, he holds nothing back. If he doesn’t like something, he says so. If emerging markets equities are downright risky, he doesn’t mince his words or try to put a puffy spin on it. That is what makes reading Swedroe so fascinating.”
—Stuart Kahan
Executive editor, CPA Wealth Provider
“For investors looking to go beyond an S&P 500 Index fund and a bond fund—and every investor should—don’t make a move until you’ve read The Only Guide to Alternative Investments You’ll Ever Need. Full of historical evidence, practical advice, and specific investment ideas, this book provides a blueprint for what to include and what to avoid in an intelligently constructed portfolio.”
—Robert Brokamp
Editor, The Motley Fool’s Rule Your Retirement service
“As a financial journalist, I’ve been recommending Larry Swedroe’s books for years because they are filled with invaluable advice that can make any reader a more successful investor. I will now be adding The Only Guide to Alternative Investments You’ll Ever Need to my favored reading list.
—Lynn O’Shaughnessy
Financial journalist and author, The College Solution
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Acknowledgments
Introduction
A Travel Guide to Alternative Investments
Modern Portfolio Theory
The Good, the Flawed, the Bad, and the Ugly
PART 1 The Good
Chapter 1 Real Estate
--Historical Returns and Risk: U.S. Real Estate,
--U.S. Equities, and International Equities
--The Diversification Benefits of REITs
--Benefits of Diversification: Sample Portfolios
--Asset Location and Real Estate
--Recommended Investment Vehicles
--International Real Estate
--DRW, RWX, and WPS
--DFA International Real Estate Securities Portfolio
--Tax Considerations
--The Wrap-Up on International REITs
--Your Home and the Asset Allocation Decision
--Wrap-Up on the Home as an Investment
--Wrap-Up on Direct Ownership
--Summary
Chapter 2 Inflation-Protected Securities
--Real or Nominal Return Bonds: Which Are Riskier?
--TIPS: Doing the Math
--Correlations with Equities and Inflation
--Inflation, Price, and Interest Rate Risk
--Inflation Risk
--Price Risk
--Interest Rate Risk
--TIPS: Pros and Cons
--Pros
--Cons
--Allocating Between Real and Nominal Return
--Fixed-Income Assets
--A Shifting Allocation Approach
--Developing a Strategy
--Implementation
--A Shifting Maturity Strategy
--I Bonds
--Summary
Chapter 3 Commodities
--Correlation with Stocks, Bonds, and Inflation
--Event Risk
--A Risk-Reduction Tool
--Portfolio Efficiency
--Gaining Exposure to Commodities
--Mutual Funds: QRAAX and PCRIX
--Commodity-Related ETFs
--Commodity-Related ETNs
--CTAs
--The Argument Against Investing in Commodity Producers
--The Equities of Oil Producers
--Implementation
--Summary
Chapter 4 International Equities
|--Emerging Markets Equities
--Correlations
--Sample Portfolios
--The Risks of Investing in Emerging Markets
--Small-Cap and Value Stocks
--Recommended Vehicles
--Wrap-Up: Emerging Markets
--International Small-Cap Stocks
--Sample Portfolios
--Recommended Vehicles
--Summary
Chapter 5 Fixed Annuities
--How Long Do Payments Continue?
--Determinants of Payment Size
--The Benefits of Annuitization
--Mortality Credits Make It Possible
--When Annuities Can Be the Right Choice
--Evidence from Academia
--When to Purchase a Fixed Annuity
--Inflation-Indexed Immediate Annuities
--Summary
Chapter 6 Stable-Value Funds
--Unique Risk and Return Characteristics
--Investment Portfolios
--Risks
--Costs
--Restrictions
--Returns Change Slowly Over Time
--Cash Flows Can Affect Returns
--Summary
PART 2 The Flawed
Chapter 7 High-Yield (Junk) Bonds
--Explaining the Low Correlation
--Is Higher Yield Worth Higher Risk?
--The Importance of Equity Risk
--Hybrid Securities and Asset Allocation
--Evidence Supported by Theory
--Do High-Yield Bonds Have a Role?
--Illiquid Securities
--Other Negative Characteristics
--Distribution of Returns Matters
--High-Yield Bonds and Efficient Frontier Models
--Inflation Risk
--Asset Location
--The Need for Diversification
--The Historical Evidence
--Vanguard High-Yield Corporate Fund
--More Efficient Alternatives
--Summary
Chapter 8 Private Equity (Venture Capital)
--Origins
--The Attraction
--The Historical Evidence
--Characteristics of Private Equity Returns
--Venture Capital Versus Publicly Traded Securities
--Inefficient Diversification
--Bias in the Data |
--Perception Versus Reality
--Private Equity’s Role in a Portfolio
--Nonmonetary Explanations for Private Equity Investing
--Summary
Chapter 9 Covered Calls
--Taxes Matter
--Transactions Costs
--An Alternative Strategy
--Summary
Chapter 10 Socially Responsible Mutual Funds
--Defining SRI
--Rapid Growth
--Does Socially Responsible Investing Come at a Price?
--The “Price” of Principles
--Summary
Chapter 11 Precious Metals Equities
--Risk
--Returns
--Correlations
--The Hedging Value of PME
--Positive Attributes of PME
--Other Considerations
--Implementing the Strategy
--Summary
Chapter 12 Preferred Stocks
--Long Maturities
--Risks and Rewards of Long Maturities
--Call Risk
--Credit Risk
--Long Maturities and Call Risk
--Dividend Suspension
--Preferential Treatment for Corporate Buyers
--Other Considerations
--Tax Advantages
--Summary
Chapter 13 Convertible Bonds
--The Realities of Convertible Bonds
--Considerations
--Shifting Asset Allocation
--Asset Location
--Complexity
--Summary
Chapter14 Emerging Market Bonds
--Risks
--Returns
--Correlations
--Potential Positives
--Additional Considerations
--Summary
PART 3 The Bad
Chapter 15 Hedge Funds
--Exclusive Nature
--Why Hedge Funds Aren’t Mutual Funds
--Facts Versus Fantasies
--Hedge Fund Risks
--Wisdom and Experience, or Hope and Hype?
--The Cost of Folly
--How High an Alpha Does a Hedge Fund Need?
--How Funds of Funds Increase Hurdles to Outperformance
--The “Ill-Logic” of Hedge Funds
--Long-Term Capital Management
--The Death of Genius
--LTCM’s Downfall: The Tyranny of Market Efficiency
--Risk Versus Uncertainty
--Fooled by Randomness
--Summary
Chapter 16 Leveraged Buyouts
--Summary
Chapter 17 Variable Annuities
--Deferred Variable Annuities
--Tax-Deferred Growth of Earnings
--The Life Insurance Component
--Ability to Annuitize
--Other Negative Features
--Are VAs Really That Bad?
--Sold or Bought?
--The Art of Deception
--Variable Immediate Annuities
--How Payments Are Determined
--The Purpose of Immediate Annuities
--Possible Reasons to Buy a Variable Annuity
--1035 Exchanges
--Other Considerations
--Summary
PART 4 The Ugly
Chapter18 Equity-Indexed Annuities
--Caveat Emptor
--Minimums That Aren’t Minimums
--Penalties for Early Withdrawal
--Tax Inefficiency
--Summary
Chapter 19 Structured Investment Products
--Mondo National Bank Principal Protection
--Notes: Product Features
--More Efficient Alternatives
--A Closer Look at Hypothetical FRATS
--Why Such “Attractive” Terms?
--More Efficient Alternatives
--Being Careful Out There
--Summary
Chapter 20 Leveraged Funds
--The Proof Is in the Pudding
--Summary
Final Thoughts
Notes
Glossary
Recommended Reading
Sources of Data
Index
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Chapter 1
Real Estate
“Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve,” advises the Jewish Talmud, which is dated somewhere between 1200 bc and 500 ad.
The quotation, one of the earliest descriptions of diversification we’ve found, shows not only that early civilization understood the need for diversification, but also that ownership of real estate was considered an important part of the process. Thus, it should come as no surprise that when investors begin to think about alternative investments, they usually turn first to real estate.
Excluding personal residences, the commercial real estate market consists of both private equity and public equity. Privately owned real estate—which includes ownership of property such as condominiums, commercial real estate, and undeveloped land—accounts for more than 90 percent of the real estate market. Public equity accounts for only about 9 percent of the total value of the real estate market. As a result, publicly traded real estate’s share of the total U.S. equity market actually understates how U.S. investors allocate their capital. For example, real estate accounts for less than 3 percent of the Russell 3000 Index. Individuals seeking to allocate their capital in a manner similar to how capital is allocated by all U.S. investors must, therefore, dedicate a separate allocation to real estate.
From the days of the Talmud until the early 1970s, the only way to invest in real estate was to actually go into the business—in other words, become a landlord. For the individual investor, private equity ownership of real estate could be (and continues to be) time intensive and expensive. It could also be difficult for an individual investor to diversify a private equity real estate portfolio by both geography and type of property.
Today’s investors, however, have alternatives. They have easy access to publicly owned real estate equity through two vehicles: real estate investment trusts (REITs) and real estate operating companies (REOCs). REITs and REOCs are essentially closed-end mutual funds that hold real estate. (Closed-end funds have a fixed number of shares, trade on a public exchange just like stocks, and may deviate in price from their net asset value [NAV].) Investors also have the option of purchasing shares of open-end mutual funds or exchange-traded funds (ETFs) that own diversified portfolios of individual REITs or REOCs.
The public markets for equity REITs provide investors with the most efficient (that is, low-cost) way to achieve broad diversification across both geography and property type (for example, offices, warehouses, industrial buildings, multifamily residences, or hotels). Public REITs also have the advantage of greater liquidity than private ownership with none of the issues surrounding becoming a landlord (see “So You Want to Be a Landlord” later in this chapter). Note: It is important to differentiate equity REITs from mortgage REITs. We would not recommend investing in mortgage REITs. Mortgage REITs hold mortgages or mortgage-backed securities. They are not equity investments. This discussion focuses only on equity REITs. (For more information about mortgage REITs, see Chapter 9 in The Only Guide to a Winning Bond Strategy You’ll Ever Need, by Larry Swedroe and Joseph Hempen.)
As stated earlier, individual investors can gain exposure to this asset class without becoming landlords. Having established this, our next task is to help investors think through whether investing in real estate will help them achieve their goals.
The investor must consider eight issues:
1. How does real estate’s risk and return compare to that of other asset classes?
2. How will including real estate in a portfolio affect the overall risk and return of the whole portfolio?
3. What are the most advantageous types of accounts for holding a real estate investment?
4. What should the investor look for when considering a specific investment vehicle?
5. What are the pros and cons of investing in international real estate?
6. What are the relevant tax issues?
7. Does owning a personal residence constitute diversification into real estate?
8. What are the advantages and disadvantages of private equity ownership?
The rest of this chapter considers each of these issues in turn.
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