Why advisors can’t ignore alternative investments

Wealth Professional sits down with one senior wealth advisor to discuss why alternative investments are so important in today’s marketplace

Why are alternative investments worthy of attention among financial advisors in Canada, and which emerging markets should be the focus? Wealth Professional sat down with Rafael Tirado, CIM, senior wealth advisor at Tirado Lalonde Group of ScotiaMcLeod®, a division of Scotia Capital Inc, to find out.

Paul Lucas: Why is it important for advisors to look at alternative investments in the current market place?
Rafael Tirado: We are facing a market where correlations between traditional asset classes are higher than ever. We have witnessed an enormous trend of large pension funds moving from 60/40 traditional asset class models towards direct ownership of infrastructure, private equity, hedge funds, etc. 

Due to this reality, it has become increasingly important for advisors to incorporate a component of alternative strategies into a traditional asset allocation model, with the purpose of further diversification and improving a portfolio’s risk-adjusted return. Alternative strategies rely primarily on alpha for generating returns. Market dislocations create opportunities that can be exploited by alternative strategies.

Paul Lucas: Which emerging market do you think is particularly worth highlighting and why?
Rafael Tirado: Rather than focusing on one specific emerging market (EM), we think there is great opportunity in EM debt. In contrast to developed markets (DM), most EM economies reflect stable or declining debt-to-GDP levels. DMs are over-leveraged compared to EM in terms of debt as a per cent of GDP. 

Today, 60 per cent of EM debt is rated investment-grade. Over the past two decades, EM economies have improved their financial positioning in paying off debt. Additionally, many EM nations have significantly larger foreign exchange reserves as a percentage of their short-term debt and foreign debt. Consequently, credit quality of EM debt has improved as a result of these improved fundamentals.

The opportunities in EM debt are extended when we consider the diversification element. Historically, EM debt has low correlation with both US equity and US fixed income. Nonetheless, it is important to remember that not all EM debt represents the same risk and reward opportunity; a proper due diligence is required to ensure the appropriate exposure is taken.

Paul Lucas: Are there any innovative alternative income strategies you would recommend?
Rafael Tirado: Partnering with an experienced institution in the alternative space is crucial. We favour relative value strategies in the global credit market space.  We feel there are great opportunities in a strategy that seeks to capitalize on market mispricings within, and across, different credit markets.

Paul Lucas: What are the pros and cons of alternative fixed income strategies?
Rafael Tirado: As traditional core fixed income fails to meet investors’ requirements of positive real returns, we have seen significant investor demand for alternative strategies like PIMCO Monthly Income, which aims to solve an investment need (income, capital preservation) rather than offer the traditional bond beta exposure.

The primary pros of this strategy is to offer real returns that are in line with investor expectations and the ability to move in and out of pockets of opportunity as markets change. The primary cons would be the increased credit risk relative to core fixed income comprised of primarily provincial and federal government bonds, and a higher reliance on manager performance (alpha).