There is a growing consensus that hard times are coming our way. One "solution" that keeps coming up is to invest in "alternatives." 20% of the asset allocation appears to be a standard recommendation. But isn't that kicking the ball downfield? Most alternatives (notably hedge funds and private equity but increasingly infrastructure, real estate, and SEG investments) underperform stock markets, correlate with each other and equities just when you need them, have a wide dispersion in performance between top and bottom tier firms (and top tier firms are often closed to new investors or have very high minimum investments). Future performance is notoriously difficult to predict based on past performance.
A recurring problem is a distortion faced by many investors and their advisors when evaluating alternative investments a distortion that is nicely explained by behavioral finance. First, there is a barrage of publicity about these firms. We know that investors are more inclined to invest in prominent firms in the news, whether for positive or negative reasons. Too, there is a star quality that the asset classes are given. Finally, there is a tendency to publicize spectacular gains or outsized deals rather than analyze their performance and risk/return ratios. It might be more helpful to admit that markets go through periods of low returns (especially after years of explosive growth) and focus more on avoiding panic reactions to today's headlines or chasing "solutions" that are flawed?
