Hear ye, Hear Ye, individual investors: Be wary of new investment asset classes – A Tip from The Skilled Investor
Many promoters in the financial services industry have shown a strong proclivity in recent years to invent and to market supposedly “new” investment asset classes. Industry advocates will claim that these new asset classes deserve some minimum percentage allocation within your investment portfolio. These supposed new asset classes have included “commodity futures,” “managed futures,” “precious metals,” the 57+ varieties of “hedge funds,” and other asset class inventions. While some of these investments are newer, many, such as commodity futures, have been around for a very long time.
What tends to be “new” about these asset classes is the increased effort by the industry to sell them to “retail” or individual investors through the broker and advisor channels. Oddly, these newly discovered asset classes for individual investors also have been characterized by relatively high sales charges, high broker/advisor compensation incentives, and high ongoing professional management costs — all paid by guess who? … You.
The primary theoretical justifications for promoting these new, alternative asset classes to individual investors have been two-fold. First, risk-adjusted historical returns for these new asset classes may have seemed higher than returns for the traditional cash, bond, and stock portfolio asset classes. Second, the volatility of returns for these new asset classes might have been relatively uncorrelated with the price fluctuations of the more traditional bond and stock portfolio assets of individual investors.
Many individual investors are susceptible to sales pitches for new asset classes, because these investors have heard that they need to allocate their investment portfolio across asset classes to achieve diversification and to align their personal tolerance for investment risk with the risk characteristics of their portfolio assets. Investments that historically have been considered to be much more speculative and only appropriate for more sophisticated investors have been declared new asset classes. If these securities instruments are sold as asset classes, then they may find their way more easily into the average investor’s portfolio. If something is an asset class, then gosh, you just gotta have some percentage of your portfolio invested in that asset class, don’t you? Perhaps. Perhaps not.
In addition, many individual investors naively extrapolate superior historical price trends into the future. They repeatedly chase performance from one investment to another. Since a great number of investors are always looking to [...]