Alternative Asset Classes That Are Easy To Own

2011 January 17
by Kyle Bumpus
from → Asset Allocation, Investing And Investments

It has been argued before that you really only need three different asset classes to construct a balanced, diversified portfolio: domestic stocks, foreign stocks, and domestic bonds (John Bogle tends to downplay the need to own foreign stocks, but he’s in the minority on that one). This is true. You really only need three asset classes. Still,  investors with enough capital (say, at least $100,000 or so) and the desire to devote a little more time to handling their investments can probably do a bit better. All else being equal and assuming you don’t mind the incremental complexity, the more non-perfectly-correlated asset classes you own, the better. There are a few alternative asset classes that are easy and cheap enough to own that make them worth some consideration.

For the purposes of this article, “easy-to-own” means there is at least one low-cost mutual fund or ETF available (preferably an index fund).

Easy-To-Own Alternative Asset Classes

Real Estate

Real estate is an obvious one, but until relatively recently only the wealthy could afford to own a diversified portfolio of income-producing real estate. Then REITs came along in the 1960′s. Now, pretty much anybody can own an interest in commercial real estate all over the country in the form of one of several very good REIT mutual funds, the Vanguard REIT Index Fund (VGSIX) being my favorite. My personal belief is that at least a token 5% of most people’s portfolios belong in REITs. I devote a full 10% of my portfolio to REITs.

International Real Estate

Okay, so international real estate rightfully belongs under the “real estate” category above; however, I’ve listed it separately here for two reasons.

  1. Until very, very recently there weren’t many reasonably-priced mutual funds that focused on owning the stocks of foreign real estate companies. It’s only been a few months now since Vanguard launched its Global ex-US Real Estate Index Fund (VGXRX).
  2. Most foreign countries don’t have the legal equivalent of the Real Estate Investment Trusts so popular with American investors. Because of this, it remains to be seen whether international real estate, as it is currently available to American investors, will behave more like real estate or more like stocks.

I’m not suggesting you go out and buy the new international real estate fund. In fact, I would lean towards advising against it (for now). But it is a traditionally alternative asset class that is now easily owned by small individual investors and so I’ve included it here.

Inflation Protected Securities

Inflation Protected Securities (TIPS) have been around for almost 15 years now and are widely owned, so it may seem odd at first that I would include it in a list of alternative asset classes. There are a number of very good inflation protected securities funds out there (Vanguard’s is excellent) and governments all over the world have been jumping on the inflation-protected bandwagon. Still, I think TIPS are under-owned and since they have explicit inflation protection, they tend to behave differently from nominal bonds, making them an excellent team. Like REITs above, I believe TIPS belong in most portfolios.

Commodities

Commodities are still the most difficult-to-own of the asset classes listed not because there are no options but because there are no truly low-cost options. This is one asset class that Vanguard has yet to offer, probably because it involves investing in futures contracts rather than equities. Yes, they do offer a Precious Metals and Mining fund (VGPMX), but that’s not quite the same thing. The best options in this asset class currently are probably the iShares S&P GSCI Commodity Index ETF (GSG, ER: 0.75%) and PowerShares DB Commodity Index ETF (DBC, ER: 0.85%). Expenses would need to be about half what they currently are before I would unequivocally recommend them for most investors. Still, investors with very large portfolios (we’re talking $500k+) would probably benefit from a small 5-10% allocation to this asset class. Just enough to gain some mild long-term inflation protection and to hopefully capture the occasional rebalancing bonus.

What About The Rest?

There are plenty of other asset classes out there:  hedge funds, private equity, foreign currencies, and venture capital just to name a few. But all of those other asset classes suffer from either high expenses, lax regulation, low transparency, or all three. In a world where the best investment advice anyone could ever receive is “never invest in something you don’t understand,” these alternative asset classes are just too dangerous for small investors. Besides between the four asset classes mentioned above and the more traditional domestic/foreign stocks and bonds, you really don’t need any more diversification.

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