Invest Well. Live Well: Alternatives to stocks and bonds

More than 20 years ago, foundations, endowments and pension plans could allocate 100% to bonds because interest rates were over 7.25% and they could meet their short and long-term objectives. Currently, a 10-year government bond only yields 0.3%, making it a challenge for institutions and retirees. To overcome this, their portfolios need more money or different strategies.

Such institutions have invested in "alternatives" to improve the quality of their returns and enhance their diversification.

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Alternatives (alts) can generally be broken down into three categories.
1) Private equity and private debt: direct ownership of or lending to companies.
2) Real assets: stable businesses in real estate, infrastructure or resources.
3) Hedge funds: employ advanced strategies like options, futures, leverage, stop-losses, shorting, etc.

In technical speak — they desire uncorrelated and superior risk-adjusted returns. According to its website, the Canada Pension Plan has drastically changed since 1997, when it was 100% bonds. In order to ensure long-term sustainability, today it sits at 11% bonds, 39% equity and 50% alts.

In the United States, most college and university endowments voluntarily reported to the National Association of College and University Business Officers. In 2017, more than 800 members — which include notables like Harvard, Yale and Princeton — reported the following average asset allocation:
4% cash.
8% fixed income.
16% U.S. stocks.
19% foreign stocks.
53% alts/

The alternative universe is a challenge to navigate because they are less regulated, less transparent and difficult to make comparisons. Many strategies have higher minimums and redemption periods of three to 12 months. Furthermore, alts can only be purchased by a licensed portfolio manager or an accredited investor, which requires a minimum level of income, investable assets or net worth.

We focus mostly on private debt and equity because their prices tend to remain stable and they can provide steady income of 5% to 8% paid monthly. Like virtually all investments, alts are not 100% guaranteed. Some alts can be risky and are not suitable for all investors. Since the 2008 financial crisis, many banks have stricter guidelines. As such, businesses look to finance loans or mortgages from non-banks and in return provide collateral and/or personal guarantees. Among the most important criteria to the borrower is speed of execution and certainty that the deal will be approved. The lenders typically look at the 5 Cs of credit: character, capital, capacity, collateral and conditions.

As the old saying goes, it is easy to make a loan, but hard to collect. If a deal goes into default, it may be resolved quickly or it could deteriorate and require enforcement which can lead to impairment (loss). Between 1998 and 2018, Russell concluded the private debt asset class loss rate was -1.1% versus -2.54% for high-yield bonds. This difference was likely due to enhanced security, covenants, control of the recovery process and an information advantage. Private lenders typically have boots on the ground and a deep understanding of the borrower's financial situation, demographics, economics, real estate laws, governments, etc.

We feel investors should review their portfolios one or two times per year. Given interest rates are near 0%, alternatives could help provide more consistent returns in this current environment. In addition, we recommend that investors work with an experienced portfolio manager to help build a more diversified and resilient portfolio for today’s world.

Until next time, Invest Well. Live Well.

Written by Eric Davis.
This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email


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