Why Alts?

2015-12-27 Janet PAINT (002)We get this question a lot, particularly as the events of the Great Recession fade away in our mental rearview mirror and the current equity bull market plods on.

Drop a dime in the jukebox and throw on “What Have You Done for Me Lately” by Janet Jackson as that is what many investors are asking about alternatives (“alts”) these days. In most cases, the answer is “not much, Janet (or Miss Jackson if you’re nasty).” But that shouldn’t cause us to change course and remove this extremely valuable asset class from your portfolio.

In fact, this is exactly the time when alts are essential to a diversified portfolio. Let’s reiterate why alts are such an important portfolio component: they are in there as a diversifying complement to the rest of your portfolio asset classes; the zig to their zag. This diversification comes in quite handy when equity returns decline, volatility increases, and interest rates rise. All of which are happening now.

So, you’re correct Miss Jackson, alts have not done much for us lately. But, as we pointed out at our fall seminars, what happens lately doesn’t dictate what will happen in the future. Recency bias is the erroneous significance that people put on recent events. As humans, we are innately emotional and hard-wired to think that these recent events will continue indefinitely. But that’s not how market cycles work. Many times, the best performer in one calendar year is one of the worst the following year. For example, REITs (Real Estate Investment Trusts) were one of the top performers in 2006 only to be at the bottom in 2007. Emerging markets were one of the best performers in 2007, only to be the worst performer in 2008. On the flip side, investment grade bonds were near the bottom of the class in 2010, only to be one of the better performers in 2011. International stocks were near the bottom in 2011 only to be one of the best performers in 2012. Hence, just because equities (and large caps in particular) have had several relative strong years in a row and alts have had muted results, doesn’t mean that will be the case for the next several years.

From 2009 through early this year, equities were providing the bigger returns and a well-diversified investor benefited accordingly. But things are changing. The Fed just raised rates, oil continues to slide, consumers aren’t spending as much, and investors could see 2015 as the first negative calendar year total portfolio return since 2008.

And speaking of 2008, let us not forget how gruesome that year would have been for many investors if not for the alternative asset class that kept returns in check. Alts like precious metals, currency strategies, and others were actually up in a time when equity benchmarks were down huge!

A basket of alternatives that DWM follows hasn’t exactly been “chart-toppers” the last few years. But that’s okay. We don’t expect for these to be double-digit return producers. As a whole, we are expecting the alternative asset class to return somewhere around 4-7% per annum for the next several years. But more importantly, our expectations for alts is that they won’t be down dollar for dollar when equities have a 10% or worse correction.

And that’s the real beauty. By using alternatives and avoiding a blow-up like many hard-core equity investors did in 2008, you don’t have a huge hole to dig yourself out of. The bigger the hole, the harder it takes just to get back to break-even, move forward, and secure those long-term financial goals of yours.

So, you’re right Miss Jackson. Alts haven’t done much for us lately. But, if you don’t fall prey to recency bias, you may understand that it is what they may do for us soon that can be so important.

Could We Be at the Start of Industrial Revolution #4?

eiffel towerThe Eiffel Tower went green (as in trees) last week, honoring the two-week Paris World Summit of 195 countries focused on cutting planet-warming emissions. Bill Gates was one of the early presenters with a big announcement. He and 28 other billionaires and philanthropies are creating a multibillion dollar clean energy fund. The fund, along with commitments from the U.S., China and ten other nations, is expected to be the largest such effort in history and is designed to pay for research and development of new clean-energy technologies. If successful, the Paris meeting could spur a fundamental shift away from the use of oil, coal and gas to the use of renewable energy sources such as wind and solar power.

As attendees at our seminars in October already know, there have been three industrial revolutions. The first, from 1750 to 1830, was started in the UK and Europe and featured steam and railroads. The second, from 1870 to 1970, was started in the U.S. and brought us planes, cars, electricity, communication and refrigeration. The third, from 1980 on, was computers, internet and e-commerce. This economic growth over the past 250 years has contributed greatly to many advances in global civilization, the reduction of poverty and improvements in the standard of living. However, it has been powered by the burning of carbon-based fuels-coal, oil and now gas. With U.S. and world economic growth now shrinking and our planet heating up, is it time for industrial revolution #4?

Research now shows that the accumulation of man-made greenhouse gases in the atmosphere is causing a massive disruption of our climate, water and food sources. While some dispute these facts, two-thirds of Americans, according to the most recent NYT/CBS poll, want the U.S. to join an international treaty to limit the impact of global warming.

Since 1880, our planet is 1.7 degrees Fahrenheit warmer. May not sound like much, but it is. Much of the land ice on the planet is starting to melt and oceans are rising. The heat accumulating in the Earth because of human emissions is roughly equal to the heat that would be released by 400,000 Hiroshima bombs exploding across the planet every day. Certainly, the risks are much greater over the long-run than over the next few decades. Yet, if emissions continue to rise unchecked, the risks are huge. As a result, the Paris summit is working on an agreement to limit the rise of global temperatures.

Let’s now bring the issue closer to home- Illinois’s neighbor to the West, Iowa. Recent polls show that 60% of Iowans, now facing flooding and erosion, believe global warming is happening. Iowa has embraced clean energy. The state’s first major solar farm is in rural Frytown supplying electrical power to the Farmers Electric Cooperative. Cornfields across the state have wind turbines, which are now providing 30% of Iowa’s electricity. Here’s the part I really like, as reported in the NYT: “Republicans and Democrats alike recognize the benefits of green jobs.”

Iowa’s new climate initiatives are a great example of what clean energy can mean. In addition to adding wind turbines, Iowa farmers are working to improve the organic matter content in the soil. One young farmer in Johnson County, Iowa planted more than 30,000 trees, introduced cover crops, composting and multispecies grazing and transformed a once degraded corn farm into a carbon capturing and storing ecosystem.

Iowa wants to be the clean energy leader. Their recent report, “The Economic Impact of Iowa’s Wind Potential to Meet Carbon Reduction Goals” highlights the expanded economic development and job creation they project.   The plan is to create 6,000 jobs building wind turbines each year and as many as 11,000 jobs for wind turbine installation. Iowa feels that clean energy could provide $3.5 billion in economic development by 2030. And, this is just one state in one country.

In a blog post in July, Mr. Gates wrote: “If we create the right environment for innovation, we can accelerate the pace of progress, develop and deploy new solutions and eventually provide everyone with reliable, affordable energy that is carbon free. We can avoid the worst climate-change scenarios while also lifting people out of poverty, growing food more efficiently and saving lives by reducing pollution.” And, we might even start Industrial Revolution #4, and give the world some much needed economic growth. We’re all for it.

Here’s to a Great Holiday Season!

santa grinch (002)We hope everyone had a wonderful Thanksgiving. Everyone on our DWM team certainly did.  Next stop: Hanukkah and Christmas.  A great time for presents of all sorts, and particularly wonderful for children’s books.  There have been some great children’s authors such as J.K. Rowling, Shel Silverstein, Richard Scary, Beatrix Potter and Maurice Sendak.  Yet, by far, Dr. Seuss has outsold them all.  His 46 books have sold over ½ billion copies. His latest “Oh, the Places You’ll Go!! (1990) is still on the bestseller list.

There are lots of interesting facts about Dr. Seuss.  Theodor Seuss Geisel wasn’t a doctor, and took the name because his father wanted him to practice medicine.  He had no kids and didn’t want any.  He is reported to have said, “You have ‘em, I’ll amuse ‘em.”  He coined the word “nerd” in “If I Ran the Zoo” (1950).  “Horton Hears a Who” is about Japan. And, “Yertle the Turtle” about Hitler.  Dr. Seuss wanted kids to start reading early.  “Oh the Places You’ll Go” was meant to be read in utero.

In the 1950s, parents and educators began to fear that American children were falling behind their European counterparts in terms of their educational achievement.  Dr. Seuss was convinced the reason that reading levels were down was because “Dick and Jane” books were so boring. (Hear Hear!) In 1955, English professor Rudolf Flesch published the influential book “Why Johnny Can’t Read.”  William Spaulding, who headed the educational division at Houghton Mifflin books, agreed with Mr. Flesch and presented Dr. Seuss with a challenge.

Spaulding had identified 348 words that first graders should know and asked Dr. Seuss to write a captivating and imaginative book using only those words.  Geisel’s first response was that the challenge was “impossible and ridiculous” but decided to try anyway.   The result:  “Cat in the Hat.”

“Cat in the Hat” (1957) used only 236 words.  It became an immediate best seller. Within three years, it had sold over one million copies.  Today, almost 60 years later, it is still a bestseller.

Flush with the success of brevity of words, Dr. Seuss produced another bestseller using only 50 words.  Yes, “Green Eggs and Ham” uses only 50 words, none of them more than 90 times.  “I” is used about 85 times as is “not”.  Then, it scales down from there with all the familiar words such as Sam, I, am, house, mouse, here and anywhere.  It has been a tremendous perpetual best seller as well.  From 1957 to 1965, Dr. Seuss wrote eight of the 35 bestselling children’s books of the 20th century including these two and
“How the Grinch Stole Christmas,” “One Fish Two Fish Red Fish Blue Fish,” and “Hop on Pop.”

What’s really amazing is that Dr. Seuss’s success is increasing, not waning.  In 2013, his books sold 4.8 million copies.  A 50% increase over 2010.  Part of this popularity is certainly the impact of the baby boomers.  In addition, his publisher, Random House, connects the books to major calendar events.  “How the Grinch Stole Christmas” at this time of year, “Oh, the Places You’ll Go” at graduation time, “The Lorax” for Earth Day and “Horton Hears a Who” for the newly created Anti-Bullying Day.  And, Random House has published seven new Dr. Seuss books posthumously.

My personal favorite Dr. Seuss book is “Horton Hatches the Egg.”   Horton, the faithful elephant, has always been one of my heroes.  “And he sat, and he sat, and he sat. And he sat all that day, and he kept the egg warm. And, he sat all night through a terrible storm.”  Horton sat there all winter through and when springtime came his friends gathered round and taunted and teased him for sitting on the nest.  But, Horton continued to sit on the egg and continued to say “I meant what I said, and I said what I meant, an elephant’s faithful one-hundred percent.”  What a great lesson of accountability.

We’re right in the middle of the holiday season.  For me, it’s not complete without reading a few Dr. Seuss books to some little ones or, better yet, have them read to you.  Priceless. We hope you have a wonderful Holiday season.