Research has shown us that investors are often compelled to act based on certain preconceived biases. These biases, whether conscious or not, skew their decision-making process in a way that could adversely affect their portfolio’s performance.
Anchoring is one such bias that has been flagged by market theorists. Anchoring is a subconscious bias towards an arbitrary benchmark, such as the price of a security when making investment decisions like buying and selling securities. For example, an investor may value an asset more if it is priced at $100 than $75.
Market participants also commit anchoring bias when they set arbitrary guidelines for their portfolios. A prime example of this is the 60/40 allocation between stocks and fixed income assets. Although the 60/40 model has been used for decades, structural shifts in the market necessitate a reexamination of this traditional model. When presented with new information, investors must do their due diligence to determine if and how to incorporate it. Otherwise, they risk anchoring their belief system in a model that no longer applies to the current market reality.
The Rise of Alternatives
The growth and widespread adoption of alternative investments—a broad category of assets that do not fall into the traditional investment categories of stocks, bonds and cash—have challenged anchoring bias over the past several years. Major changes in the economy, radical shifts in monetary policy and declining real yields in fixed-income securities have all compelled investors to look beyond traditional investments. As a result, global alternative assets under management have topped $10 trillion, having grown 55% in just seven years.
Alternative investments have been shown to provide significant diversification, risk and return benefits, especially for investors with a long-term view. Increasingly, investors view Alternatives as a necessary component of a well-balanced portfolio.
Portfolio Construction and Asset Allocation: How to incorporate Alternatives?
So, how much of your portfolio should be allocated to alternatives? The answer will depend on your underlying goals, current asset mix, risk tolerance and investment horizon. However, examining Canada’s top pension plans provides a good barometer when thinking about alternatives.
Canadian pension plans have a lofty objective: To build financial security in retirement for millions of people. According to data from Manulife Investment Management, pension plans in Canada with over $500 million in assets under management allocate roughly 35% of their portfolio to alternatives. Pension plans with less than $500 million have a fifth of their portfolio allotted to alternatives.
When deciding to incorporate alternatives into a portfolio, it’s important that you define your objectives and then research the available options. For example, if your investment decisions are driven by inflation hedging, capital preservation, portfolio diversification or fixed-income diversification, you should select alternatives that align with these goals.
How CMI can help you
Private mortgages and other forms of real estate exposure represent one of the fastest-growing and most attractive segments of alternative investments. CMI Investments has over a decade of experience in the private mortgage market, having completed over $700 million in mortgage placements. CMI conducts proper due diligence, risk management and adjudication practices in sourcing the best possible mortgage deals for investors. Contact CMI for more information on our investment offerings.