Phil-in the Gaps: Why Alternative Investments Belong in Your Retirement Portfolio
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm revisiting the world of alternative investments. You might recall the episode that I published a couple of months ago discussing alternatives and if retirement savers should invest in them. In short, I concluded that while alternatives tell a compelling story, the large majority of products and solutions don't meet their stated expectations. They're not

that most retirement savers likely would not benefit from adding alternatives to their diversified portfolio. Well, today I'm joined by Phil Huber, author of The Allocator's Edge and chief investment officer at Savant Wealth.

Through Phil's research and writing, he's come to a different, more optimistic conclusion about alternative investments. And that's exactly why I invited him to come on the show today. I wanted to better understand how he thinks about alternatives, how he defines them, and why he thinks they're a valuable addition to a diversified portfolio. I also wanted to give him the space to share what I and others might have previously gotten wrong about this complex asset class. And

And to support Phil's work on this topic and further help our listeners come to their own conclusion about alternatives, I'm excited to share that I'm giving away 10 copies of his book, The Allocator's Edge, A Modern Guide to Alternative Investments and the Future of Diversification. Phil is a wonderful writer and does an incredible job breaking down this asset class and breaking it down in a way that everyone can understand.

Unlike prior giveaways here on the show, to give all time zones an equal opportunity at getting a free book, 10 listeners' names will be drawn at random. To throw your name in the hat, just head over to this episode's show notes page, which can be found by going to youstaywealthy.com.

forward slash one eight seven. On that page, you'll see a short giveaway form where you can quickly add your name. The deadline to submit is Monday, May 8th at 1159 PM and winners will be announced shortly after. Once again, the show notes for this episode, including the book giveaway form can be found by going to you stay wealthy.com forward slash one eight seven. Okay. Without further ado, here is my conversation with Phil Huber.

Any investor has a broad menu of sorts that they can choose from when it comes to building a portfolio. And so when you think of how the vast majority of investors allocate their dollars, it's typically through some combination of stocks and bonds. And what we often refer to in the industry as the 60-40 portfolio, 60% stocks, 40% bonds. And the reasons for this are multiple. Number one is that portfolio mix amplifies.

absent 2022, has done quite well over a multi-decade period. And so it's delivered good results to investors over time, both in an absolute and a risk-adjusted sense. It's gotten increasingly easy to implement that type of portfolio as time has gone on, as technology has improved and costs have come down. You can get pretty much

entire global stock and bond market exposure through one, two, or three mutual funds or ETFs. So very, very easy, just a few clicks of a button, a couple of ticker symbols, and you're kind of on your way. It's very intuitive. I think even the most novice investor

I think understands the role of stocks in a portfolio is there for long-term growth and appreciation, the role of bonds, more for stability, defense, income, et cetera. So you don't have to be a CFA charter holder to understand why you would want to blend those two assets together. And then there's everything else that we broadly and loosely refer to as alternative investments, which in my opinion really tells you

not so much about what something is, but more about what it isn't. And for a long time, it wasn't something that the average investor had to pay a lot of attention to because most of what we would deem to be alternative tended to be things that were more institutionally focused. So investments and asset classes that were more

the domain of your large pensions, endowments, foundations, et cetera, or perhaps just the ultra high net worth type investor. As time has gone on, like anything in life, technology gets better, access improves. And so you're starting to see more and more of these different types of alternatives become more readily accessible to your average high net worth investor in the marketplace. And so what that has brought to the forefront is this idea of should investors expand their palette effectively?

a bit to include other things beyond stocks and bonds in a portfolio as a form of additional diversification or potentially to play some sort of either return enhancement or risk management role in a portfolio to perhaps maybe pick up the slack a bit where either stocks and or bonds might fall short.

That's the decision facing a lot of investors today is how to exactly tackle that space. Like you alluded to, the term alternative investments is broad and people have all sorts of different definitions for what's an alternative and what's not an alternative.

How do you define alternative investments? What do you consider? What don't you consider an alt? And maybe even share some examples of specific asset classes that you personally own or some of your clients own and talk us through some of those different asset classes inside the alternative category. I always like to say when the topic gets brought up, someone says, should I be invested in alternative investments? I'll often say, well, alternative to what? And alternative to whom?

We've talked a little bit about alternative to what, and that's kind of your stocks, bonds, cash, everything else fits in that. But there's also a little bit of it that the definition is in the eye of the beholder. And so something like private equity, for example, might be alternative to URI. But if you're the CIO of CalPERS or something like that, you've been investing in private equity for decades. And so it's not quite that alternative to you. Something like Bitcoin, we'll use it as an example, is alternative to URI.

probably alternative to my grandmother, maybe not so much to my 25-year-old cousin. So everyone has their own perception of what constitutes alternative. And it's also this constantly evolving definition. If you look at things that are fairly commonplace today in diversified portfolios of traditional asset classes, you'll typically see things like emerging market stocks or publicly traded REITs for real estate exposure or things like high-yield bonds.

Very few people would really consider those to be alternatives today, but those were asset classes that were essentially in their infancy in the 80s and 90s. And at that point in time in history, very much were kind of on the frontier or considered more alternative. And so the definition's evolving, and it's very much in the eye of the beholder as well.

When I think about the bigger categories of alternatives in terms of media attention or dollars allocated to, you typically tend to think of private equity, venture capital, hedge funds, real estate, and maybe gold or commodities or things like that.

In addition to those categories, there's also an emergent, I would say, group of alternatives that are maybe less mainstream, but becoming more broadly accessible today. One being what I broadly call alternative risk premia, which is similar to hedge funds in some ways. But if you think of it as taking certain types of hedge fund strategies and applying them in a more rules-based, low-cost, more transparent type of wrapper, and that would include things like managed futures or

global macro strategies or things like event-driven strategies. Then you've got things like insurance-linked securities, which is getting exposure to catastrophe event risk, which is a wholly uncorrelated source of returns relative to financial markets. And then you've got private debt, which is sort of a cousin of private equity, but more focused on income. And then we talked about real estate a little bit. There are other types of real asset classes out there, things that are based on tangible assets with some

element of cash flow and inflation sensitivity. And so that could include things like infrastructure, farmland, or timberland. And so there's plenty of others that we could go into, but in the interest of time, we'll maybe pause there.

You mentioned that alts can be defined a number of different ways and it is an eye of the beholder there. Do you believe that an alternative has to have certain characteristics? For example, does it need to be uncorrelated to traditional stocks and bonds? Are you looking for something and evaluating it a certain way to say this is an alternative and this is not? Second to that, would you consider a low-cost publicly traded REIT fund to you? Is that an alternative? Is a low-cost Vanguard tips fund? Is

Is that an alternative in your eye? I personally don't think of those two as alternatives. I would think of tips, as you mentioned, as just a component of a broad fixed income allocation. REITs are a sector of the global stock market. And so that might be akin to calling healthcare or utilities an alternative. They're just sectors of the marketplace. And so

Alternatives don't necessarily have to be totally uncorrelated. I think it ultimately depends on what are you trying to achieve with your allocation. There are certain, if you think about like a bell curve sort of thing, there are certain types of alternatives that are exposed more to right tail risks. Things like venture capital, perhaps, or crypto would be a couple of examples there. Maybe others that are focused more on left tail risks. So extreme downside could be certain.

Certain types of hedging strategies, things like that. And then you've got other alternatives that I think, again, if they can solve for some sort of intuitive risk premium that can deliver a meaningful risk-adjusted return over time in isolation. And I think if you can combine that with traditional assets in a way that it is complementary due to the independent nature of its return strategy.

driver, that kind of serves as more of your core alternatives. So when I think of how we utilize alternatives at Savant, we focus more on what are the core alternatives that are what we think ways to augment a traditional stock bond portfolio that improves overall risk adjusted returns and creates a greater degree of resiliency to a broader spectrum of different macro and economic type of environments.

You referenced a number of different alternative categories or asset classes. One that more recently has made headlines is managed futures, especially last year where managed futures funds had a pretty good year. So it's come up a lot more in recent years.

I don't want to go through every definition of every alternative category, but given that managed futures has made more headlines recently, would you mind just sharing what managed futures are? Like when you're buying a managed futures fund, what are we buying? What is that? The reason it's called managed futures is the word futures in the name is in reference to the fact that rather than buying a stock or a bond, the instruments being used in these funds are typically futures contracts or other derivatives. And the managed piece refers to the

this idea that the exposures are dynamic. And so there are futures contracts and derivative contracts that are liquid in nature that encompass everything from equity indices to interest rates, currencies, commodities, and so really across the different types of asset classes. And essentially what most managed futures funds do is try to

capture this trend behavior that there's a lot of great research in academia that supports this notion of trend following being a valuable type of investment strategy, kind of rooted in behavioral finance where prices essentially drop.

don't necessarily move in a complete random walk. They tend to exhibit trends more often than not. And these trends can be positive trends and asset that has been rising in price may continue to rise in price. And one declining in price might see some short-term negative momentum or continues to decline. And so trends aren't always there, but the idea is that if you can invest across dozens, if not hundreds of different futures contracts and have the ability to take long or short positions, depending on the direction of that trend, you're

you can get a pretty diversified return profile and one that historically has actually done very well exactly when you want diversification the most, which tends to be when everything else in your portfolio is doing quite poorly. And so if you look across the data that we have for managed futures and you look at the worst quarters for something like the S&P 500 over that several decade time period, you can see fairly reliable returns.

In most cases, relative and absolute terms, meaning managed futures has the ability to deliver positive returns in really stressed environments for equities. And so it could be a really compelling diversifier, but like any alternative or any other form of diversification, there are no

silver bullets, if you will. I think that's a common mistake that folks entering alternatives for the first time have is these sort of unrealistic expectations that just because something's uncorrelated, it's going to work all the time. The good news and the bad news is the good news is they can be valuable over time and improve a portfolio. The bad news is they're not always going to show up. And so you have to have a long time horizon. You have to have patience and discipline because what you run into, which I think you were maybe alluding to, is that

that often everyone wants to shut the barn door after the horse is already out, meaning they experience a year like 2022 or maybe prior to that 2008, they see that something like managed futures did quite well during that period when stocks and bonds maybe didn't do so hot. And then they want to add that diversification more as a reaction as opposed to having that preparation built in from the get-go. The flip side of that too is...

if you had been following the asset class for years prior, it's no surprise that the 2010s were a challenging decade for managed futures. It was a pretty long equity bull market, and it was just an environment that didn't lend itself well to managed futures funds. And so for those that were already allocating, a lot of folks did not have the patience to stick with it. And if you just look at flows for the category, you see a lot of outflows in the years leading up to 2022. So even folks that were

in the asset class, maybe didn't eventually reap the benefits when it eventually showed up. And so that's not a challenge that is specific necessarily to alternatives. We see return chasing behavior all the time in investing, stocks, bonds, alts, everything. My view there is any type of alternative you're going to introduce to a portfolio should really be more from a strategic standpoint, something you feel like you can buy and hold over a long period of time and not just

try to time it or make some sort of tactical adjustment based on your view on where stocks or bonds might be going. Because there can be long winters, if you will, for any type of asset outside of T-bills. There's no guarantees or no real risk-free type of return. So you're still bearing risk. It's just the idea is that this is an independent and diversifying source of risk relative to the things you already own. I'm jumping ahead a little bit, but since we're on managed futures, I want to ask this question. I

I think one of the challenges with allocating to an asset class like Managed Futures, let's imagine that one of our listeners here is bought into Managed Futures and feels like it would complement their current portfolio. One of the challenges that I've come across is that not all Managed Futures funds are the same. Some did very well last year, some didn't. And so you really have to look under the hood and understand how that fund is positioned and how it's managed and those nuances. Are there any...

high-level tips that you can provide if someone wants to go shopping for a managed futures fund to add to their portfolio? Again, we know there's a number of different alternative investment categories, but just zoning in here on managed futures while we're on it. What are you looking for when you're evaluating managed futures funds to know that you're getting the fund, you're getting the exposure that you're actually looking for? Yeah, it's interesting in the sense that managed futures funds relative to, say, large cap equity index funds are different in the sense that

There's probably 10 different S&P 500 ETFs you could pick from. They might have different expense ratios by a few basis points here and there, but by and large, they're quite fungible with one another. It doesn't really matter which one you pick for the most part. When you look at other categories of investing and you look year by year or over time, you can see a wider degree of dispersion in terms of your better performing funds and

worst performing funds. It may seem at the surface like they're all kind of doing the same thing, which is by and large trying to apply a trend following strategy, but they may differ quite a bit in terms of how they implement that, in terms of what types of markets they're willing and able to trade, what sort of volatility they're

level that they might be targeting at the overall fund level, what sort of trend signals they might be focused on. Some funds focus more on short-term trend signals, other on longer-term trend signals. And so those different design choices and implementation choices could actually mean a lot different actual realized returns. For someone who doesn't want to spend a ton of time trying to weed through every fund and decipher what they think might be the most optimal solution, there are approaches out there that offer exposure to multiple managers with

within one fund. And that might be a way to get more of a smoother ride in the asset class, where you're not betting on one single trend following manager, but maybe a broader set of those where you're trying to get more of the asset class return as opposed to the variability that comes with any single manager. So that's one consideration to keep in mind. And I think that can be applicable perhaps to other types of all categories, especially as you move more on the illiquid side into areas like private equity and

venture capital, you see much greater dispersion between your top quartile and bottom quartile performers. And really, the difference between success and failure in allocating to those areas is going to be more contingent on which jockey you're betting on as opposed to the horse itself. Whereas in public equity markets that are more efficient, you're kind of really more betting on the horse, if that makes sense. In your book, The Allocator's Edge, which will be given away to a handful of listeners here today, you referenced this acronym that you came up with,

SHARP. Talk to us about what SHARP is and the underlying meaning of each of those letters in the acronym. What I wanted readers of the book to come away with was not this idea that there's some sort of perfect portfolio out there that's going to solve all their problems and get them

great returns every single year with no risk. That's not the idea. I think, obviously, the message of the book is positive in general on alternatives. I don't want to overgeneralize there because like anything in investing, there's good, there's bad, there's ugly. I think there's certainly some alternative categories that can have value and others that I would shy away from. But really, the acronym is more about less of a specific

portfolio per se more of a framework and a mindset to approach investing with? Whether you're building your own portfolio or if you're someone in our seat, if you're an advisor or some sort of allocator of other people's capital, how should you think about building portfolios? And so the acronym SHARP is

sensible, humble, autonomous, resolute, and persevering. By sensible, it's really this idea of, is this investment grounded in data and common sense? Why should I expect to make money in it over time? And is it supported by evidence? Being humble is just this idea of the future may not look like the past, rather than try to predict where inflation is going or interest rates are going. Why don't we prepare for a very uncertain future?

and to do so through diversification. This idea of being autonomous is really just about, it can be really hard at times, but just really trying to be

curious and also an independent thinker and not necessarily just always follow the crowd when it comes to best practices, particularly for those that are working on behalf of others, being resolute. In other words, always understanding, bringing yourself back to this idea of what is the purpose of this money and making sure that we're focusing on our clients' outcomes more than anything else. And then lastly, P for persevering. Investing is a long game. It's a marathon, not a sprint.

While alternatives may have the potential to improve the odds of successful outcomes over time, it's not going to show up every year. You have to have patience in order for these things to work over time. And so just this idea of being process-oriented and focused on the long game. So really combining those attributes together, easier said than done, of course. We don't all get up every single morning with complete sensibility and humility and autonomy, etc.,

To me, it's something to, I think, strive for over time to be a better investor. While we're talking about your book here, Cliff Asness kindly wrote the foreword to your book and

I'd love his few pages there. It sounds like both you and Cliff, at least at the time of this writing, were both on the same page with regards to traditional stock and bond portfolios, suggesting that these traditional 60-40 stock bond portfolios are being challenged and will continue to be challenged going forward. Talk to us about why those portfolios will be challenged going forward and

And maybe why you think, if you think, that the opportunity to add alternatives to a boring 60-40 portfolio might be more compelling today than, I don't know, a few years ago or even 10 years ago.

The math there has really been more focused on the 40 of the 60-40, meaning the bond piece. In other words, your starting yield on bonds is a fairly good predictor of what you can expect to earn in returns over the subsequent, call it five to 10 years. And that was really where the alarm bells were going off. It wasn't necessarily something you ever want to market time. But really the idea, if you think about where we entered 2022 with interest rates, essentially at zero on the short end and historically low levels further out on

on the yield curve, it didn't paint a great picture for what to expect over the next five to 10 years. Now, the potential outcomes were one of two paths. What we did experience, which was fast pain, which was rates going from zero to over 4% in short order, less than a year, that was the double digit,

declines we saw in bonds last year, that was short pain. The other potential, if we didn't see inflation potentially go up the degree that it did, would have been probably more of a long pain, which is, I think, probably a worse outcome longer term for investors and savers and retirees, which was, what if the 10-year stayed at 1.5% for the next 10 years? That's a bad outcome too, because if someone's got 40% of their portfolio in fixed income, then that's really going to mute their ability to meet their objectives and

take income from their portfolio, all these things. And so the good news after a year like last year is that expected returns are now higher. And that's

the same for bonds, that's the same for stocks, and the same for a lot of alternatives as well. If you think about the risk-free rate, that's sort of the center of gravity and almost the sort of rising tide that lifts all boats. And so I think in general, whether you're allocated in a traditional stock bond portfolio or one that's more diversified with alternatives, you should feel better about your forward-looking returns than you did 12 to 18 months ago because of that big shift in interest rates. And so that being said,

it's still not an easy environment to get a sizable return with not taking a lot of risk. There's a great study by Callen, who's a big institutional consultant that they update periodically where they said, what type of risk would it require to achieve a 7% expected return? And so if you go back to their study in 1993, you could get a 7%

return by being almost 100% allocated to just core fixed income. I think they show it's like a 97% bond allocation and 3% large cap stocks, and you could have an expected return of 7% with a fairly low risk profile. If you fast forward it to 2022, before the start of last year, essentially, you almost had to take three times the amount of risk to achieve the same expected return. And so it's gotten increasingly tougher to get a

If we fast forward from 2022 to 2023, the math looks better, but it's still not anywhere like what it was in 1993. So as much as rates have gone up, at the end of the day, 10-year treasury around three and a half or so around the time of this recording, it's certainly better, but we're still not quite back to an environment where you can get a really high expected return from a conservative portfolio. And so I think, again,

Yeah.

And I think it's just this idea that diversification is the only free lunch in investing. And if you can find things that are truly independent and uncorrelated and have an intuitive risk premium associated with them, those are things that you might want to consider owning to build a portfolio with. And so that's kind of my thinking on that.

I'm not familiar with the Callen study. I'll have to get a copy of that or get a link to it. And we'll put it in the show notes. It's kind of chuckling as you're talking about that. One of the most downloaded episodes on this podcast is an episode I did titled how to get a 7% rate of return. So I talk a lot about those different time periods where it was a lot easier. It probably came from them. I'll send you the link afterwards. It might have, maybe I have come across it and I was influenced by it.

So we'll make sure to put that in the show notes and I'd love to check it out again. Another question kind of popped up as you're talking there, and maybe this changes and evolves depending on the current environment. But when you look at that boring 60-40 portfolio and you say, okay, I want to inject alts into this portfolio. And let's just say, I want to carve out a 20% allocation to alternatives.

You kind of led your answer by saying, really, the stock portion isn't necessarily the problem. The bond portion has historically or in recent years been the problem. When you inject that 20%, in your mind, are you taking that from the bond allocation? Are you cutting your bond allocation in half? And now you have a 60-20-20 portfolio? Are you taking a little bit from stocks and a little bit from bonds? How do you think about where alts fit in and enter into that 60-40 portfolio?

Is it always the same or does it change depending on projected forward-looking returns or expected returns? It's really up to whoever's deciding on that particular decision. There's different ways to approach it. If you're taking it all or almost all from fixed income, it's likely that you are increasing your expected return, but probably adding a little bit more volatility to the portfolio. If you're taking it all from equities, you're likely lowering the portfolio's expected return

but maybe orienting it more towards capital preservation. So I think, again, it always goes back to what are the client goals and objectives that we're trying to achieve? And also what types of alternatives are we considering? There's some alts that might be more appropriate to bucket alongside equities, others that might be more appropriate substitutes or complements to bonds. And so it's hard to come up with a generalized answer to that question.

that question. In the book, you have this great quote, which I appreciated. You said, most allocators like the idea of uncorrelated returns, but balk at the actual experience of owning uncorrelated return streams. So they like this idea and concept, but when they actually go to apply it and try to implement it, they don't enjoy that experience. Why have investors really struggled to historically adopt alternatives? Why is it such a challenge to have a good experience owning alternative investments?

I think especially when you think of things that are uncorrelated, I was actually listening to your episode on alternatives from a few weeks or a couple of months ago as part of my prep for coming out with you. I didn't know what I was getting into. And I think you mentioned this idea of the notion of alts or something that's uncorrelated is that it might zig when something else is zagging. And I think that's actually a common misperception of actually what uncorrelated means. For something to zig when the other thing is zagging, you're assuming it's doing the opposite.

That's actually negative correlation. In other words, if I can tell you something's going to be up when stocks are down, there's a negative correlation there. That sounds great in theory. We'd love to have confidence that we had a bucket of our portfolio that anytime stocks were down over a given week or month or quarter or whatever, that we had another piece that was guaranteed or had a high likelihood of being up. The challenge is that most things that are negatively correlated to stocks

either have a very low or negative expected return. An easy example here would just be like buying puts, put options. That's a great way to ensure that you're going to get a pop if stocks go down quite a bit. The challenge is if you're just buying puts systematically over time, you're pretty guaranteed to lose money because maybe it pays off one time out of 10, but the other nine times you're just paying a premium and losing money. And so the things that

have that negative correlation that we all seek or desire don't also come with the benefit of having sizable investment returns. Things that are uncorrelated are a little bit harder to hold in practice because we lack that intuition on how they should behave or how we want them to behave depending

depending on the movements of other things in our portfolio. And so if something's really uncorrelated, you could tell me that stocks were down 20% last month, and I can't tell you if this all was up, down or sideways, because they're not linked in any way. And so that can be really frustrating. It worked well for those that own something like managed futures last year. But

It's more challenging when you've got a year where stocks are up 20 plus percent and the alternative is up single digits or negative or something along those lines where it becomes this pain point where you want everything to be working and it seems like something is sticking out like a sore thumb. So one of my favorite quotes from our mutual friend Brian Portnoy on diversification is that diversification means always having to say you're sorry, because if you really have a diversified portfolio, there's always going to be something that is disappointing you.

I think that's a really important distinction about negative correlation and uncorrelated returns or uncorrelated return streams. I think there is this misconception with investors when allocated into alternatives that these alternative investments are going to protect me during catastrophic time periods. We go back to 08, 09 and everything is a mess. But if I have alternatives, alternatives are going to save me. I think part of that has to do with

the marketing of alternative funds. When traditional asset classes are suffering, you see these alternative fund companies and their marketing departments going to town, marketing their solutions. So investors are naturally kind of connecting the dots saying, gosh, well, I guess when traditional things suffer, I would expect alternatives to kind of save me. That's not necessarily true. Is that your line of thinking? And I guess just

If we look at alternatives in isolation, your expectation is not that they're going to save you during catastrophic time periods. Is that accurate? No, nothing's going to save you, especially if you're maintaining your core exposure. It might help you.

have lower drawdowns or manage risk a little bit more than you otherwise would, but it's not going to flip a negative into a positive in a catastrophic type of year. And again, it depends on which alternatives you're talking about. Things that are more equity oriented are probably going to suffer and go down alongside equities. You might have others that are more reliable in stressed environments, but maybe have

less sizable returns in other environments. And so certainly the marketing engine is going to continue to do what they do when it comes to these things. And I don't think we do ourselves any favors there necessarily, but I think it's also a function of

sizing a 2% allocation to alternatives, no matter what it is, is not going to do anything. I think for those that are trying to decide what, if anything, they want to do in this world, in my opinion, there's no right answer, but it's got to be enough to matter, but not so much that it's going to overwhelm the portfolio and lead to an experience that an investor can't stick with. And so if you're debating zero or one or 2%, just stick with zero would be my opinion there and just maintain the

simplicity and comfort that comes along with that. Because adding an alternative, it's not as easy as just saying, okay, this works on paper, this works in a spreadsheet. There's a lot of decisions you have to factor in around how to size it, where to source it from, how to think about taxes, how to think about costs, and just the experience of owning them. If you're managing portfolios on behalf of others,

You can't just throw these things in there and expect your clients to stick with them over time. You have to put a really concerted effort around education and setting proper expectations because I think that's where a lot of folks get into trouble in all this is just having unrealistic expectations. And so if you're not prepared for that journey and the commitment that comes with that, you may be better off just keeping things simple.

as an alternative. At the end of the day, to reference back to Cliff Asness, who wrote the foreword to the book, I think I probably quoted him like 10 times in the book. He's a very quotable guy, but he's always had the saying that the best portfolio is the one that someone can stick with. And I would certainly agree with that. I agree too. And I just think it's important to emphasize here that

I talk a lot about bonds and misconceptions in bonds. And just like bonds, when it comes to alternatives, there are different levels of risk that you can take with your alternatives. And I think it's important to understand exactly what you're buying and the risks that are associated with those. And actually, that brings up a good point is that you got to go beyond the label, by which I mean, this was an aha moment that a lot of people had in 2008 was just...

Just because something has bond in the label, not all bonds are created equal. There's different degrees of interest rate risk and credit risk. And so you have to really look under the hood. It's like more about not just looking at the thing about like going to the grocery store, not just looking at the front of the cereal box, but looking at that nutritional label to really understand what nutrients are you getting, not just what someone calls itself because nutrition.

At the end of the day, you can create a really pretty pie chart and have a lot of different line items in a portfolio. But if all of those individual funds or holdings have the same overlapping risks, then you're not truly diversified. Strategic Income Opportunities Fund. There you go.

You mentioned this a few minutes ago, fees and taxes, and that certainly comes up in the alternative investment conversation. How do you think about fees and taxes when allocating alternatives, knowing that in some of these there is a little bit more of a tax drag, so you have to keep that in mind and what types of accounts you might be owning these? And then also, and maybe it's a question to you, is it fair to say that alternatives are more expensive? And that is an important consideration. Maybe starting with the tax side, painting with a broad brush, I think...

They tend to be less tax efficient than an equity index fund. Certainly can vary by category. What you want to have an understanding of is what is the turnover of the strategy? Things that have a higher degree of turnover might have a greater propensity to distribute capital gains. Could be long-term, could be short-term, some combination thereof. And so being mindful of the associated tax rates with those and maybe being cognizant of locating certain asset classes in tax-deferred

account types to try to shield those and retain more of the overall return. Other types of alternatives are more income-oriented. And so if the vast majority of the return is coming from ordinary income distributions, again, maybe lends itself to trying to hold inside of a tax-deferred account. So at the end of the day, you want to make sure you're not just assessing the expected return of a particular asset class, but also the net of tax expected return as well if you're a

When it comes to cost and fees, there's no getting around it. Alternatives are more expensive. And when we live in a world of essentially free exposure to total stock in bond markets, if you can get those types of exposures for single basis point expense ratios, for all intents and purposes, we'll call that free beta. Anything that's more expensive is

does get scrutinized further and frankly should be scrutinized. You don't want to just pay up for something not knowing if you're getting the value in exchange. And so I think first it's important to understand what causes a certain type of investment to be low cost versus high cost. In other words, why is the Vanguard Total Stock Market Fund able to offer single digit basis point expense ratios? Well, it's got essentially infinite capacity. And so thinking about a fund spreading its fixed costs over a larger base is

having that type of infinite capacity allows you to deliver that type of thing. The other is they're interchangeable. And so when you think about what would cause something to cost more, one is that capacity. So things that have lower capacity tend to be more expensive. And that's one of four, I call it the four C's of investment costs, things that lend themselves to higher fees in general. And so capacity is one.

Two other ones are what I call craftsmanship and complexity, which are essentially how do you design and implement the strategies to deliver real world results? And those come with additional investments in people and technology and expertise. And that just tends to add to costs. And then the fourth C is contribution. In other words, something that

has a strong risk-adjusted return and is complementary to things you already own, that's a valuable thing to have in a portfolio and you should probably be willing to pay up for it a little bit. It doesn't mean that any expense makes sense at a certain point. To quote Cliff Asness again, there's no investment strategy so good that it can't be made bad by too high of a fee. It's tricky because when we're comparing fees on traditional assets to alternatives, we're not comparing apples to apples.

Fees should always be an important consideration when evaluating any investment, but it shouldn't be the only consideration. And I think especially in the world of alternatives, just buying the lowest cost option is not as indicative of good outcomes as it might be in stock and bond allocations.

So fees and taxes are certainly important considerations when evaluating different alternatives. Another might be historical data, historical performance. Again, it's not the end all be all, but one thing people often go and look at is how has this fund performed throughout history? And maybe we should also say too, we're talking about alternatives in isolation here. And I think both you and I, while we might disagree on some things, we do agree that we should be evaluating the global portfolio, not just evaluating the

alternatives and isolation, but how those alternatives behave and how they complement other traditional asset classes we might own.

Pushing that aside, historical data might be an important consideration when evaluating these different alternatives. As you and I know, historical data in the alternative asset class space is kind of lacking. It's a newer asset class, as you kind of mentioned at the top of this interview. How do you think about the lack of data compared to traditional asset classes, which we have a lot of? Does that make you more hesitant or should it make someone else more hesitant to allocate to alternatives? What do we do with this lack of historical data?

I think that's a bit of a myth in a way. And there's certainly maybe not as much data, like index data on certain alternative categories. But there's actually more, I think, than people realize. If we're just thinking about indexes to use for the purposes of, hey, like a lot of funds maybe don't have long histories themselves, but we might be using some kind of index as a proxy for what you should expect in that asset class over different market cycles over a long enough period of time.

Maybe we don't get all the way back to 1926 like we do for the S&P 500, but there are indexes for insurance-linked securities, for private debt, for private real assets that have histories going back 15, 20, maybe 25 years or so. It's not always readily available to everybody, but there is data out there, probably more so than people realize.

The other is that I think we often overlook the fact that when you think of approaches to equity investing today about tilting towards factors, factor investing is a popular way to invest, something that you mentioned earlier, you and I disagree on some things and agree on others. I think that's probably one area that we do agree on is certain types of factor exposures, whether we're talking about the value premium or other things. If you actually look at all the academic literature that initially brought these ideas to the forefront,

what they're showing there is actually long, short portfolios. In other words, all the academic papers that are citing the existence of a value premium, for example, they're not saying here's what buying a bunch of cheap stocks looks

delivered over time. They're saying, here is the return from a long-short portfolio where your long basket is your really cheap stuff, your short basket is your really expensive stuff when you sort it based on some kind of fundamental metric. It's interesting to me that a lot of allocators and advisors

cite these papers and all this academic evidence as reasons to support how they invest their long-only equities, but they're more hesitant to actually implement strategies in that long, short way that is actually the way it's shown in the literature. And so when you look at a lot of the papers, whether it's size or value or other types of factors, that's how it's referenced in there. And so I think there is, again, maybe not

investable index data, but certainly backtests, which again, there's all the usual caveats that come with backtests. You might want to probably give them some haircuts when you're coming up with your own

expected forward returns just because as things get discovered and become more popular, they might not deliver the same results that they did in the past. But the same could be said for traditional investing too. And that we can tell you what the S&P 500 did from 1926 to today. The challenge is index funds didn't exist until the 1970s. And even then, no one really cared about them. And so we have the great benefit today of standing on the shoulders of giants and having just reams of data to use to inform how we build portfolios.

the people two, three generations ago, they didn't have that luxury. And unless you had a time machine, there's no way to go back into the 1930s and say, I just want to buy the US stock market broadly. There wasn't an easy way to do that. So I know it's a long-winded way of answering your question, but I would say there's a lot of asset classes that more recently have become more accessible through different types of fund structures and things like that. And maybe they don't quite have the lengthy history of index returns or asset class returns, but I like to just

point out a few examples of ones that have what's known as the Lindy effect, which is this notion that if you look at non-perishable things, so not people or food or things like that, but ideas, technologies, this notion of the Lindy effect is referenced to the longer something has been around, the likelier it is to be around in the future. And so things like private debt, insurance-linked securities or reinsurance, real assets, things like farmland,

Those have been around for centuries or in some cases like millennia. These are not new ideas. They're more what I would call old wine packaged in new bottles. And so even though there might not be a ton of data, the intuition and just the notion of these have been ways that people have invested throughout history, I think should hopefully give comfort as to that they're going to continue to be around and persist in the future. I think those are really excellent points. I appreciate you sharing all that. It brought another question to my mind recently.

In thinking about historical data, one of the challenges with alternatives is some of these funds that you're buying, they have a lot more opportunity to invest in different things. Like one hedge fund is not the same as the other hedge fund. You can kind of go wherever you want as the manager. And so that does create this like, how do I measure this?

this fund and the history and the performance first, the other one. A long way of asking, when you think about allocating to alternatives, should we be buying an index-like fund in the alternative space? Or do you believe that it should be actively managed by somebody when we buy an S&P 500 fund or a fund that's tied to a traditional index? That's a good question.

That fund has to stay true to that index. It can't really go wherever it wants. So it gets a little trickier in the alternative space. And I know there's some index solutions that have come to the surface in recent days, recent years. How do you think about indexing passive investing in the alternative space versus active? It's tougher in the sense that there aren't a lot of

index products available for certain categories. There's ways to invest in some where they might technically be active, but the vast majority of the return is coming just from that broad exposure to the beta, if you will. And so, yeah, I think absent a thoughtfully constructed and well-designed index fund, I think there's still ways to attract

achieve what you want is that you're not seeking alpha per se, but you just want that broad asset class exposure. You still might be taking a little bit of active management risk, but maybe it's a multi-manager vehicle, or at least you're spreading out your manager risk across a number of

different managers within a single fund is one way to approach it. The other would be like in certain types of hedge fund categories. Again, hedge funds are not an asset class. They're a fund structure. There's dozens of different hedge fund strategies, some valuable, some not. And within those categories, there's going to be good funds and bad funds. I think for

Investors that are more oriented towards passive approaches and rules-based constructs, there's plenty of, I would say, systematic approaches to hedge fund type strategies out there where, yes, they're still active in implementation, but not because...

some person's waking up every morning and deciding they want to go long this and short that. It's a very systematic approach where they're relying more around algorithmic approaches and not trying to outguess their models. And I know a lot of our listeners like to go and take action with these things. And if any of our listeners are wondering what

what funds should I consider buying or even start to research. And in your book, The Allocator's Edge, which we'll be giving away and I'll link to in the show notes, I know in the back of the book, you lay out a number of different alternative funds with the ticker symbols. And so people can go and look a little deeper and do their own research. So I just want to make sure that we mentioned that. Before we part ways today, I want to be conscious of our time here.

You referenced earlier that you took a listen to my recent episode I did on alternative investments. You mentioned to me privately that you were screaming obscenities while listening to your car driving to work. I know we do disagree on a few things here, but I've really enjoyed this conversation. I want to just...

give you some space. What else in that episode do you think I got wrong? What else might retirement investors take into consideration beyond what I shared when considering alternatives in that episode? For those listening, I wasn't actually screaming obscenities. Taylor and I are buddies, so I feel like I can bust the shops a little bit. There was nothing I necessarily disagreed with. I think we already talked about the kind of zig versus zag thing and just this maybe misperception people have around uncorrelated versus negatively correlated. The study that you referenced in that episode,

What was interesting there was like, this is notable across all of investing is that results can be really different depending on your choice of start and end dates. I know that study covered like a 20, I think so period ending end of 2022. And I was looking at a number of different hedge fund strategies. What was interesting is that I was like flipping through my book and I had a similar table of like hedge fund category returns, except the data I had at my disposal at the time when I was writing, it was like end of 2020 hedge

over like a 20-year period, but that included 1999. And that was interesting too, is that the results looked a lot better there because if you think about what was it like a really great period for hedge fund strategies was that 2000 to 2002 bear market when the tech bubble burst, a lot of hedge fund strategies did really, really well. And so I think the study that you were referencing there started in 03, and so it didn't capture that multi-year period. So I think not to say that either is wrong or right, it's just the data is what the data is. It's called endpoint bias and that you're

Starting and ending points of a certain data set can have really extreme impacts on your results that are being displayed. You always want to make sure you're trying to measure things over as long of a data set you can and looking even within those at different sub periods to account for different parts of the market cycle. I think there's also a little bit of commentary around data.

I think it was private REITs or non-listed REITs you were talking about. I think people think of liquidity as this binary concept of, oh, you've got daily liquid things like mutual funds and ETFs, and you've got totally illiquid investments like private equity or venture capital or something like that. And what we've seen in recent years is kind of growth of what are called like semi-liquid funds. That could be anything from interval funds to tender offer funds to private REITs. And I think what's important with those is that they all offer some version of periodic liquid

liquidity, hence the name like semi-liquid, but it's not guaranteed. And so I think that was something that if you're not going in with

eyes wide open and really understanding what you're buying, you might get surprised if you're trying to go redeem and get your money out and you can't get all of it back at once. And so there's trade-offs involved. To have that periodic liquidity, what it does, these different structures, it opens up different types of asset classes you can own that you can't necessarily own inside of a mutual fund or an ETF because there's a liquidity mismatch.

But at the same time, you have to sort of treat them as long-term investments because at the end of the day, these type of funds, they have restrictions on how much liquidity they're willing to offer in a given period. They're willing to offer some, but there's always this ability for something like a gate to go up that might limit maybe instead of getting fully redeemed out in a quarter, you get partially redeemed.

That mechanism is there. It's more of a feature than a bug. Maybe it's frustrating if you didn't really realize it. If an advisor put someone in that that didn't quite explain to them what they were buying, then shame on them. But I think that semi-liquidity is a nice to have, but you don't always want to depend on it because it's written right there in the fund prospectuses.

in terms of what type of liquidity they're willing to offer. And again, having the ability to impose gates or restrict redemptions is for the benefit of remaining shareholders that aren't trying to exit so that the manager is not forced to fire sale illiquid assets at rock bottom prices. And so I think you're going to continue to see popularity of these semi-liquid structures because it does allow for

other types of diversification that liquid funds don't offer. But we need to be mindful that they're not a panacea and that you really got to understand the liquidity provisions for each strategy. Yeah. And I think that really pairs well with where I wanted to wrap things up today. A quote that I jotted down from your book said, great investments and great portfolios are nothing if not paired with great investors. So

It is really important to look under the hood and really understand what you're buying and what all these nuances are. And if you're not prepared to do that, not interested in doing that, maybe find a great advisor to help you. Or you do just stick with that boring 60-40 portfolio that you know and you understand. Warren Buffett often comes up in these conversations about being a great investor. And gosh, he's a testament to that quote. He has bought and hold these companies that have gone through all sorts of different trajectories.

troubles and difficulties along the way, it's really not easy to be that investor, to buy and hold and never sell and stick with things for the long term. So hopefully, you know, that's the takeaway that it is important that you understand these things and that these great investments or great portfolios are nothing if not paired with great investors. Also, the other big takeaway for me is that there is no perfect portfolio.

portfolio. I often share the same quote that the best investment philosophy is the one you can stick with. So really, really good stuff, Phil. Where can people find you? You write an amazing blog, Bips and Pieces. You work at a great firm. Tell us just a little bit about you, your firm, your blog, where people can find you. And we'll be sure to link to everything in the show notes.

I'm the chief investment officer for Savant Wealth Management. I joined the firm a little over three years ago. We're based in Illinois, but we've got a footprint in, I think, 10 different states now and about 25 different offices. And we've been around for over 30 years as a firm providing counsel to individuals, institutions around investment management, financial planning, and other forms of wealth management. So great organization. You can find a lot of my content on

on our website, which is SavantWealth.com. We've got a blog there and I publish pretty frequently there. And then as Taylor mentioned, I've got my own separate investing blog called Bips and Pieces. It's BPS and Pieces. Really thankful and appreciative to be here. And thanks again for having me on. Absolutely. Love the topic. I could talk forever. Appreciate your time, Phil. Thanks so much.

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