Why Your Asset Allocation Strategy Needs Adjusting

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Did you know there is a vast discrepancy between how individuals and institutions allocate their investment capital?

According to the 2017 American Association of Individual Investors Asset Allocation Survey, the average individual investment portfolio consisted of about 66% equity, 16% fixed income, and 18% cash. While individual portfolios are highly skewed in the direction of equities, the same does not hold true for large institutional investors such as college endowments or pension plans whose asset allocation models look quite different.

According to a January 2017 report from the National Association of College and University Business Officers (NACUBO), university endowments report average asset allocations of 35% equity, 8% fixed income, 4% cash and 53% alternatives.

All this begs the question. Why the dichotomy?

The simple answer could be a matter of access. Individual allocations are a product of habit. With 401(k)s and IRAs heavily invested in mutual funds and with investment advisors heavily skewed towards equities to drive up fees, it’s easy to see why individual investors prefer the convenience of Wall Street.

So, why is it that large institutions, who are not beholden to employee retirement plans and investment advisors, choose to allocate a majority of their assets to alternative investments? The simplest answer is the returns are better.

For example, the Yale University Endowment, one of the largest university endowments in the country with over $30 billion under management, is known for its progressive investment strategy with allocations of over 75% of its assets in alternative investments, including 9-11% in real estate. For 2018, Yale reported a return of 12.3% for the fiscal year. Compare that to a return of -4.38% by the S&P 500.

Alternative investments are  shielded from the volatility 
of Wall Street.

As evidenced by the 2018 returns of the Yale endowment and the S&P 500, alternative investments are shielded from the volatility of Wall Street. Along with serving as a buffer from Wall Street volatility and offering above-market risk-adjusted returns, alternative investments also offer recession resistance, diversification as well as tax benefits, which explains the preference by large institutions and high-net-worth individuals (“HNWIs”) for alternatives.

Back to the question of why the difference between individuals and institutions in their asset allocation models?

We touched on convenience. Individuals tend to stick with what they know and what has been traditionally accepted. Wall Street has been familiar and convenient.

We touched on accessibility, and historically, the alternative asset class including private equity, commodities, and real estate have had higher minimum investments and entry points than traditional investments, shutting out many individual investors. Institutional investors like university endowments don’t have that problem since according to NACUBO the average university endowment was almost $640 million. Unless you ran in the right circles or had a tremendous amount of cash, alternative assets were out of reach.

The good news is what was historically true about asset allocations by individuals and institutions no longer has to be perpetuated as sea changes have already been ushered in that will make problems of accessibility to alternative investments for individuals a thing of the past.

With the passage of the JOBS Act and the loosening of the advertising restrictions previously imposed on private equity offerings, alternative investment opportunities are now readily available to individual investors like never before.

Various investment crowdfunding and private placement investment platforms are making alternative investments more accessible to individual investors, often with lower investment minimums.

This increased access to alternative investments is already moving the needle. Data suggests individuals are now starting to gravitate towards alternative investments just like their institutional counterparts.

According to a recent investor survey from Millennium Trust Company, LLC (“Millennium Trust”), a leading retirement and institutional custody services provider to advisors, financial institutions, businesses and individuals, HNWIs have pulled back on their investments in stocks, bonds and mutual funds and instead have reallocated their capital towards more alternative assets including private equity, real estate and hedge funds.

The survey, which asked 500 HNWIs about their current holdings and future investment strategy, showed less than half of all participants, or 47 percent, invested in individual stocks in the past year – a 10 percent decline compared to last year. Almost one-third of respondents reported investing in real estate.

For individual investors, the playing field is finally leveling.

High returns and shelter from stock market volatility are no longer reserved strictly for wealthy institutional investors. These same benefits, available through alternative investments such as real estate, are now available to individual investors willing to step outside the familiar and discover what large institutional investors have known for decades.

By following the lead of institutional investors such as the Yale endowment that has experienced an average annual return of 11.88% over the past 20 years compared to 7.63% by the S&P 500, you too can build wealth through alternative investments.

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