“I’m interested in longevity, timelessness, style – not fashion.” – Ralph Lauren
In part one of this topic, we discussed human longevity and how living longer – along with the quality of one’s overall health – can increase the demand on one’s retirement portfolio. I also proposed the notion that the overall health and sustainability of a retirement portfolio is an aggregate of underlying components, tax structure, monitoring/rebalancing, and the stress (volatility, income/spending needs) placed upon it. In this part, we’ll begin to identify investments to help increase portfolio longevity. With this in mind, strategies that can help to achieve growth of principal and income, reduced volatility, and increased yield can have a lot of utility, but it’s seldom possible to find all of those attributes within a single strategy.
On the traditional side of investing, one approach that is always top of mind within our team is that of Dividend Growth investing. If done well, it means that we can create an increasing income stream through the ownership of companies that consistently grow their dividends. It’s relatively straightforward but perhaps underappreciated in the era of index/large-tech growth investing in which we find ourselves. Although we expect that dividends can grow regardless of stock-price appreciation –even through times of market stress, as we experienced in 2020 – stock prices have generally also risen over time.
Those three attributes make Dividend Growth investing a valuable tool for portfolio longevity: income growth, price appreciation, and consistency of income during volatile periods. It may have the added benefit of exhibiting lower volatility, but I consider this to be a bonus if/when it occurs, rather than something that needs to be relied upon for being a valuable portfolio component. David Bahnsen has literally written volumes on this topic, so I won’t go into more detail here, but check out his weekly DividendCafe or book, The Case for Dividend Growth: Investing in a Post-Crisis World, for more insights.
Staying within the traditional realm for a moment, it may already be clear to you that public bonds used to have strong characteristics for portfolio longevity, but that we have witnessed a major paradigm shift. While the income stream didn’t appreciate over time, bond yields were once high enough to provide an excellent source of retirement income. The seemingly endless descension of rates meant that bond prices appreciated consistently (the 10yr Treasury yield has declined from over 15% in 1981 to its current level below 1%, and the total return of the 10yr Treasury benchmark from 1981 through mid-2020 was 7.57% per year! Sources: FactSet & Zephyr StyleADVISOR). At the same time, bonds were relatively stable and could even provide portfolio protection during equity-market turmoil.
Could owning the U.S. 10-year Treasury still make sense to help protect a portfolio in the coming years? Yes, but it may offer little upside return. With historically low rates, traditional fixed income, like the 10yr Treasury, cannot play the role it once did. I expect that it can still offer more yield than cash and provide a source of funds to buy more equities during selloffs. As discussed in part one, the reduced utility of traditional fixed income is a big part of why we need to look elsewhere for longevity solutions – and this is where alternative investments enter the conversation (finally).
Over the past decade, alternative investment access has broadened in scope, and the playing field has leveled substantially. I believe that this “Alts democratization” has come at a perfect time, in light of the current challenges that most investors face. As discussed below, there are now many Alt strategies available to retail investors, some of which even provide exposure to private investments.
In my experience, this “more liquid” side of Alts has taken over 15 years to get to its current state of providing access to some true alternative exposures in more investor-friendly vehicles with substantial track records for analysis. We’ve seen fatal flaws of various strategies play out (with some funds blowing up completely), and I have my fair share of emotional scarring from a select few funds. On the whole, however, I think this evolution is powerful and positive, given that the investments are reasonably understood and properly used within one’s portfolio.
Many alternative strategies can be found in daily-liquid mutual funds (e.g., long-short hedge funds that manage publicly-traded stocks). On the other hand, private strategies – which tend to have the risk/return/income characteristics we seek for portfolio longevity – will more likely be found in structures that offer limited liquidity. Options range from interval funds and business-development companies (BDCs) to private-partnerships (including private REITs, LLCs, and LPs for our purposes here). Because these funds may offer only a small amount of redemptions to investors, they can construct a portfolio of less-liquid assets, like private loans or commercial real estate – investments that often require multiple years to manage through a cycle. In short, providing less liquidity to end-investors means less likelihood of forced asset-sales to meet redemptions.
Some interval funds may be available to retail investors with no qualification requirement, but – generally speaking – the other structures will have some additional income or net worth restriction associated with them. As I covered in the post, Framing the Solution, managers can help limit liquidity through lockups and gating (e.g., redemptions no more than 5% of the fund value on a quarterly basis); they can be easy to get into but sometimes tricky to fully liquidate, so be sure to know what you own, and go into any of these investments with the intention of a long-term hold.
As I mentioned above, it’s easy to find Alts in daily-liquid mutual funds or ETF formats these days. It’s far more difficult to find strategies that exhibit characteristics that make them suitable fixed income replacements. I believe many alternative funds can outperform traditional fixed income in the coming years on a total return basis (yield + price appreciation). However, the challenge is to find solutions that offer a) high enough yield and b) low enough volatility to replace a portion of traditional bonds in a given portfolio.
I don’t think there is a perfect solution to this problem. There are undoubtedly good solutions that can put investors in a far better position over the long term, but the “A-team” consisted of owning longer-duration Treasury Bonds during the 40 years of falling rates. That A-team is dead. The mission hasn’t changed, but we’ll need to accomplish it with the B-squad, which means adjusting some of our expectations. Over the course of the next two alt.Blend segments, we’ll go into more detail about these adjustments and strategies that may work well to help replace traditional bonds and enhance portfolio longevity. Perhaps they won’t be highly fashionable, but, hopefully, they’ll get the job done.
For those with fond memories of 80s TV shows: unlike our deceased A-Team of Treasury bonds, most of TV’s “A-Team” – B.A. Baracus (Mr. T), Face, and Murdock – are still alive (at least as of April 2020, when this video was made), but George Peppard, who played Hannibal, passed away in 1994. RIP.
Until next time, this is the end of alt.Blend.
Thanks for reading,