How can I optimize a portfolio of traditional and alternative assets?

Genevieve Signoret

(Hay una versión en español de este artículo aquí.)

This article was originally posted on Quora a while back but is non-perishable and continues to draw interest. Its target audience is people who manage their own money. The question was: “How can I optimize a portfolio of traditional and alternative assets?”

For purposes of this response, I define alternative assets as any you invest in for the purpose of saving (that you see as part of your wealth) that are not publicly traded. I use the term interchangeably with non-liquid and call publicly traded assets liquid ones.

One dimension you want to optimize on is diversification. Seek to combine asset classes that exhibit low correlation coefficients across asset classes you hold and try not to dramatically overweight any one class.

To find correlation coefficients for a mix of liquid assets and alternative (not publicly traded) assets, for the alternative assets, you want to find a liquid “proxy” to see how the asset class performs on public markets. For gold, it’s easy, you have a public auction tracking gold prices and a couple of gold ETFs. For real estate, often you can find a publicly traded REIT or ETF that is a basket of REITs for the segment of real estate you’re invested in (e.g., U.S. residential).

Now find an online tool that can produce a correlation matrix and input your traditional (publicly listed) stocks and bonds as well as the liquid proxies you found for your alternative assets. I prefer tools that measure correlations in total return (take into account income generated, not just prices), but if you can just look at correlations in terms of price (valuation) it’s better than nothing. To optimize along the dimension of diversification, fiddle with your portfolio choices to get the positive correlation coefficients down.

Generally speaking, your lever to fix unduly high concentrations in any one asset class is your liquid portfolio, precisely because it is composed of liquid assets. For example, suppose you make a sizeable investment in a friend’s startup in the tech industry, then perform the exercise I propose above (using as a proxy a ticker for a company or ETF of companies your friend’s startup will compete in) and discover that you hold way too much tech, your portfolio is allocated mostly to tech stocks and they exhibit extremely high cross-correlations. It will be almost impossible for you to adjust the alternative asset component of your portfolio because shares in a startup are not liquid. But you can easily and cheaply make a few trades to diminish your relative concentrated exposure to tech inside your liquid portfolio to offset the high concentration in tech that you have in your alternative asset portfolio.