When the stock market is climbing, the parts of your portfolio that aren’t keeping pace can stand out pretty quickly.
If the S&P 500 has posted solid gains while one of your alternative investments is producing a much more modest return, it’s reasonable to wonder if that investment is doing what it’s meant to. You may also wonder why a meaningful portion of your portfolio is allocated there when there seems to be more upside in public equities.
We hear varying versions of those questions from investors fairly often during rising markets.
The challenge is that a diversified investment portfolio is built from moving parts that may respond differently to the same environment, often intentionally. If every holding moved in lockstep with the stock market, you wouldn’t be getting much diversification from them.
Some investments may participate more fully when stocks are performing well, while others may rely on different sources of return or serve a different purpose within the portfolio allocation. That means comparing every holding with the best-performing part of the portfolio can give you an incomplete picture of whether it’s doing its job.
So if one of your alternative investments is lagging while stocks are rising, its recent return makes more sense when you look at the role it was selected to play within your broader portfolio.
What Are Alternative Investments Supposed to Do?
“Alternative investments” can be a broad term, and not every strategy is meant to accomplish the same thing.
Some may be used to generate income, while others may give investors access to opportunities outside of the public stock and bond markets. Or maybe there are pieces in place meant to help reduce how dependent a portfolio is on the same factors driving traditional investments.
It’s important to be mindful of an investment’s role in your broader portfolio because an alternative investment should be judged based on the role it was selected to play.
At Towerpoint Wealth, we look at alternative investments in the context of the broader portfolio. Not every holding is designed to produce the same type of return at the same time. Understanding how each piece contributes to the portfolio can help investors decide whether a holding still fits their goals, time horizon, and liquidity needs.
Why Can Alternatives Lag When Stocks Are Rising?
When stocks are having a promising year, it can be tempting to use the S&P 500 as the measuring stick for everything else you hold in your portfolio.
The problem with this is that alternative investments may respond differently to certain market forces than publicly traded stocks. Their returns may be tied to private businesses, lending activity, real estate, or other sources that don’t always move in step with the overall stock market.
The comparison between your investments can also be affected by how often each investment is valued. Public stocks are repriced throughout every trading day, while some private investments may report updated valuations much less frequently, so the performance you see at a particular point in time may not reflect the same measurement period.
Because of these different factors, a strong rally in stocks doesn’t necessarily mean every other part of a diversified portfolio should be rising at the same time.
Consider an alternative strategy designed to produce steady income from a mix of sources outside the stock market, such as specialty lending, private credit, and commercial real estate. In a year when stocks surge, its returns can look dull by comparison. But in a year when stocks fall sharply, a strategy like this may hold up much better, and that’s when its role becomes clear. Its job was never to keep pace with the rally. It was to keep working when the rally stopped.
That’s true of diversification more broadly. There will often be something in a diversified portfolio that looks disappointing next to whatever’s performing best at the moment. If every holding benefited from the same conditions, they would likely share more of the same risks as well.
There can be a temptation to sell whatever has lagged and put more money into the investments that have performed the best recently. Over time, however, repeatedly chasing the strongest part of the market can leave a portfolio much more concentrated than intended.
Portfolio construction looks at how investments behave together, not simply which holding produced the highest return. At Towerpoint Wealth, we build around a strategic asset allocation and rebalance as market performance changes those weightings, rather than continually shifting more money toward whatever has performed best most recently.
The better question is whether the investment is performing as expected for the role, and whether that role still adds value in your portfolio.
Alternatives: How Much is Enough?
If an alternative investment is supposed to have a meaningful impact on your portfolio, the allocation has to be large enough to actually influence the outcome.
A very small position can technically add another type of investment to your mix, but it may do little to change the portfolio’s overall risk, income, or characteristics of its return. That’s not to say that a larger allocation is automatically better, but the appropriate size depends on what the investment is there to accomplish and how it fits with everything else.
For example, an investor with significant exposure to public equities might use alternatives differently from someone whose priority is generating income or preserving liquidity. Factors like time horizon, tolerance for risk, and the amount of money that investor may need access to can all affect how much of the portfolio it makes sense to commit.
Our advisors at Towerpoint Wealth look at alternative investment allocation as part of a portfolio’s overall design. The allocation should be large enough to have the intended effect without creating liquidity, risk, or income trade-offs that don’t fit the rest of the financial plan.
Has market performance changed your portfolio’s intended mix? Learn more about how rebalancing can bring an allocation back toward its targets over time.
Alternatives Should Still Earn Their Place
Alternative investments often come with trade-offs that are different from those of traditional stocks and bonds. Different return drivers can support diversification, but alternative investments can still lose value and may not provide the same benefit in every market environment.
Depending on the strategy, investors may have less access to their money, pay higher or more complex fees, receive valuations less frequently, or deal with additional tax reporting as a holder of alternatives. Some strategies also depend heavily on the decisions of a particular manager, which can add another layer of risk to be aware of.
These considerations are all part of deciding whether an investment makes sense for a particular portfolio. If the strategy is no longer contributing in the way it was expected to, or if an investor’s liquidity needs, tax situation, or financial priorities have changed, the allocation may need to be revisited.
A diversification strategy still needs to include investments that justify the role they were assigned, even if each player is expected to perform differently.
How Should You Judge an Alternative Investment During a Rising Market?
A rising stock market can make it easy to see the differences between investments. That makes it a natural time to review why an alternative is in the portfolio and whether it still makes sense.
Start by thinking back to the role the investment was expected to play. Then, look at how it’s actually behaved and what has changed elsewhere in the portfolio.
Here are a few questions to help guide your review:
- Is it behaving the way it was expected to, compared with similar strategies rather than the S&P 500?
- When markets were weak, did it do its job?
- Has anything changed underneath it, such as the manager, the strategy, or the fees?
- Has strong stock performance pulled your overall allocation away from its targets?
- Do the liquidity, fees, and tax reporting still fit your plan today?
Market performance is only one part of an investment review. Looking at the investment alongside the rest of the picture can help you decide whether the strategy and allocation still make sense for where you are today.
If rising markets have you wondering whether anything in your portfolio should change, read The Stock Market’s at an All-Time High. What Should Investors Do Now? for our perspective on reviewing your allocation without reacting to recent performance alone.
Final Thoughts
When stocks are climbing, any investment that trails behind them can look disappointing; that makes periods like this a great opportunity to revisit what each holding is there to accomplish and how it fits with the rest of the portfolio.
Every investment should continue to have a clear role in your portfolio. If an alternative strategy is still contributing in the way it was intended to, a weaker return than the S&P 500 may be consistent with how the portfolio was designed. If that role has changed, or the trade-offs no longer fit your financial plan, it may be time to revisit your allocation.
If you’re reviewing your portfolio and wondering whether your alternative investments are serving their purpose, schedule a complimentary 20-minute “Ask Anything” Conversation with Towerpoint Wealth.
