If you like having a complicated portfolio and owning exotic asset classes for diversification, you might want to prepare yourself before reading Skating Where the Puck Was: The Correlation Game in a Flat World by William Bernstein. Most of the exotic classes you’ve ever thought about owning will be struck down:

  • Commodities futures? – disaster.
  • Private equity? – nope.
  • Hedge funds? – don’t bother.
  • Gold? – sorry, even the Permanent Portfolio would have been better off historically without gold if you measure since 1980 (after going off gold standard).

The basic premise is “Rekenthaler’s Rule”: If the bozos know about it, it doesn’t work any more.

Even international stocks are not nearly as useful a diversifier as they used to be. The book included a chart of the correlation between the S&P 500 (developed large-cap US stocks) and EAFA (developed large-cap international stocks), but I found a more recent one from Morningstar. International stocks used to offer high returns and low correlations, the ideal asset class to add to any portfolio! Not so much recently:

Now, there are still reasons to invest in international stocks – primarily the “big picture” deep risk of investing in a single country over a long period of time. But your short-term volatility is not going to be dampened much anymore.

So, what is left?

The best alternative asset class for the average investor may be in truly private investments, such as already mentioned, owner-managed (the owner being you) residential and commercial real estate in distressed markets, or in other private businesses in which you have special expertise.

I would be careful with this too, as there are many bad (quiet) real estate investors and failed/struggling businesses that you don’t hear about. Be sure you really have “special expertise”. However, one benefit of owning private real estate or a private business is that you don’t get daily price quotes. Nobody is going to tell you “Well, if you sold TODAY, the best price you could find is 50% of what you could have gotten last month! Tomorrow, it could only be 40%! Do you want to sell?!”. This means less likelihood of panic selling and more long-term investors.

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Don’t Expect Too Much From Exotic Asset Classes from My Money Blog.


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