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By Liu-Yue (Louie) Lam, Co-Founder, CEO, Oxstone Capital Management

Equity Market Commentary and the Growing Demand for Alternative Investing

We expect the economic environment to continue to be treacherous for investors over the intermediate future.  The private sectors (consumers and businesses) in the developed world (U.S., Europe) will continue to deleverage 25+years of debt accumulation.  At the same time, big governments will likely continue to lead the charge for increasing regulations and increasing taxes in the face of huge fiscal deficits.  The rapid rise in precious metals (gold and silver) and soft commodities (food prices) are signaling higher inflation in the near future.  This will likely lead to slower spending, slower growth, higher taxes, higher regulation, higher interest rates, and chronic higher unemployment in our future.  In such an environment, investors globally are now more concerned with the return of principal than the return on principal.

Alternative asset classes may offer investors the best of both worlds.  Alternative asset classes may provide respectable returns with lower volatility than traditional asset classes.  The uncorrelated nature of many of these alternative asset classes make them even more attractive when compared to the extreme volatility of return performances in the equity markets over the past few years.

The long term stock market returns over the past 84+ years is roughly 9.8%.  Although, the stock market has rewarded long term investors it required strong tolerance and patience with long 20 year holding periods.  There are intermediate time periods and even longer time periods when the stock market has produced negative returns.  We may still be in a negative return cycle.  For the past ten years (2000-2009) the equity market has produced an average negative annual loss of (-1%).  With current cyclically adjusted market P-E’s (20x) above the historical average range (15-16x), investors can expect below average returns in the equity markets over the intermediate term – 5-7 years at roughly 6-7% but with high volatility.  Any recent returns gained in the market due to massive dislocations caused by temporary monetary policy manipulations may be short lived and robs from future performance returns.

There is now a growing market for absolute returns.  Our belief is that producing an average net total return in the high single to low double digit return with low volatility is extremely attractive given the current economic environment.  Although, it’s always possible to outperform the expected future average stock market returns; the number of individuals who possess the superior stock picking abilities to do so are rare.  Therefore proper diversification and asset allocation strategies will be critical.  A host of alternative investment asset classes such as emerging/frontier market equities, international real estate, commodities, private equity, and hedge fund strategies may provide institutional and retail investors with better risk adjusted returns in the current low return environment.

Lastly, adding alternative asset classes as part of your overall investment portfolio simply makes sense as it will greatly enhance your chances to outperform the markets simply from reducing your portfolio risks due to the uncorrelated nature of many alternative asset classes with traditional asset classes.

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