Exotic Investments That Offer Gains, but Also Pose Risks | Long Island

Exotic Investments That Offer Gains, but Also Pose Risks

Stocks are scary these days and too risky for many investors. Cash instruments and government bonds have yields close to their lowest levels ever. That combination could heighten interest in the myriad funds that focus on exotic, none-of-the-above assets.

More than 20 exchange-traded funds and mutual funds introduced since the stock market plunge of 2008 furnish access to such niches as private equity, managed futures contracts, various hedge fund strategies and foreign currencies like the Chinese renminbi. They are worth a look, financial advisers and analysts say, because these markets may offer higher returns than mainstream assets or move in uncoordinated cycles, possibly lowering overall portfolio volatility.

“I’d be interested in some of these,” said Darren Young, senior product manager for E.T.F.’s at RBC Wealth Management, part of the Royal Bank of Canada. For investors looking to diversify into alternatives, “it might make the most sense to get liquid exposure through one of these E.T.F.’s.”

But advisers encourage wariness, too. While alternative asset classes are nothing new, the novelty of many funds, the esoteric nature of their holdings and investors’ unfamiliarity with them are sources of potential risk.

“A lot of people can’t use regular investments to get them where they want to be, so they’re forced to look into some of these exotic investments that, five years ago, they would have spit at if you had mentioned them,” said Lee Johnson, a Fort Worth financial planner. “Having more choices is good. The problem for most of these is that they don’t have much of a track record. It’s a great story, but show me what you’ve done.”

There certainly are more choices and, as Mr. Johnson suggested, many of them are just getting out of the starting blocks. Five E.T.F.’s investing in alternatives began trading in 2011, and they have been joined recently by some unusual mutual funds.

Guinness Atkinson Renminbi Yuan & Bond has been going since July. It hardly could have been started much earlier; the renminbi, or yuan, does not float freely on international markets — authorities have begun to loosen their grip on the renminbi-dollar exchange rate only in the last few years — and the Chinese bond market has existed for just over a year, the fund’s manager, Edmund Harriss, pointed out.

In an indication of just how many arcane asset classes and investment methods there are, Litman Gregory Masters Alternative Strategies was introduced this month. It’s a vessel containing portfolios run by four outside managers using various unconventional approaches, like arbitrage, a hedge fund strategy in which the goal is to profit from discrepancies in the prices of related securities, like the stocks of companies on either side of a merger.

Funds like these are most suitable for well-off investors who are between fabulously wealthy and middle class, advisers say. The very rich often enter exotic niches through vehicles not open to the public. As for small investors, even a modest stake could be excessive; alternatives are recommended to be held in thin proportions — thinner still for any individual strategy.

“First and foremost, you need to be adequately diversified,” Mr. Young said. A position of “3 percent to 5 percent is as much as anyone can handle” in any particular alternative fund, in his view. For that to work out to a meaningful dollar amount in a portfolio, “you need at least six figures” of liquid net worth.

Sometimes such wherewithal is a prerequisite. While E.T.F.’s can be bought in virtually any amount because they are traded on stock exchanges, mutual fund providers set minimum investments to eliminate prospective shareholders for whom their funds may be inappropriate.

Litman Gregory requires a $1,000 stake in Masters Alternative Strategies. The figure is $10,000 for the Guinness Atkinson Chinese currency fund, high enough that only the fairly well-to-do could manage a holding that was small enough to minimize risk to the portfolio yet large enough to deliver meaningful returns.

Much of the fund’s $78 million in assets, as of the end of August, has come from high-net-worth individuals making a typical investment of $50,000 to $200,000, Mr. Harriss said. While Chinese local currency debt may seem like a racy investment objective, he observed that shareholders were using the fund in place of bank deposits or money market funds rather than as a replacement for, say, Chinese stocks.

“We can’t call it a money market fund, but it’s something that people are looking at in that part of their allocation,” he said.

The performance has been far closer to that of cash than the Chinese stock market. From July 1 to Oct. 17, the fund fell about 1.5 percent, compared with a 13.7 percent decline for the Shanghai Stock Exchange Composite Index. Investment advisers shared no misgivings about any specific fund or exotic asset class. Some expressed concern, however, that limited size and a narrower investor base could make some niche markets more fragile than stocks or bonds.

“People need to be very cautious about these things,” said Ronald W. Rogé, a Bohemia, N.Y., financial planner. “They need to understand them. They’re investing in something where the market is very small and there’s not much liquidity. If there’s a run on that market, a fund is going to drop significantly, so you need to have your eyes wide open.”

Mr. Rogé prefers to steer investors into portfolios called world allocation funds, which are hybrid vehicles with characteristics of mainstream and alternative funds. Their managers generally have latitude to invest in assets of all sorts in any region or business sector. They can also go short, betting that the price of a security will fall.

Having such broad discretion should be alternative enough for most investors, in his view. Beyond that, he expects the most astute managers of such funds to do a better job of blending assets into a portfolio than the typical private investor or financial adviser. Some that he recommends are Pimco All Asset All Authority, First Eagle Global, Robeco Boston Partners L/S Research and AQR Risk Parity.

Investors who decide instead to build their own portfolios of alternatives should make sure to study the asset classes and candidate funds carefully, Mr. Rogé added. “It’s important to understand what you’re getting into,” he said, “so that if it blows up you blame yourself, not anyone else.”

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