“It is advisable to look from the tide pool to the stars and then back to the tide pool again.”

— John Steinbeck, The Log from the Sea of Cortez

We write this month’s letter from Vancouver, where we are spending time with clients. Steinbeck’s advice suits the moment: watch the large forces, then look closely at what they mean for your own portfolio. This year, interest rates have risen sharply, driven partly by the U.S. Federal Reserve and partly by tariffs, and expectations of persistent inflation have pushed them higher still. We expect some relief. De-escalation in the Middle East conflict should lower oil and energy prices, and as tariffs stabilize, inflation should soften further. In our view, part of the recent bond sell-off reflects investors selling out of fear of further increases rather than a change in fundamentals.

Rising rates usually cool the economy and, with it, equity markets. This year has been an exception. Heavy investment in artificial intelligence has driven stocks higher, lifting not only technology companies but also the businesses that supply them, including chipmakers, data centre builders, power utilities, and industrial equipment makers. Meanwhile, a tight U.S. labour
market and strong consumer demand suggest the underlying American economy remains sound. Canada is benefiting from growing investment and trade with a broader set of partners, including Europe, India, and China.

Bonds still have a place in client portfolios, depending on risk tolerance and income needs. Having said this, we tend to favour corporate bonds over government bonds, as they can offer higher yields and better income potential for investors who are comfortable taking on modest additional credit risk. This month, however, we focus on a newer growing group of investments known as liquid alternatives.

The Power of Combining Asset Classes

In the 1950s, Harry Markowitz developed the Nobel Prize-winning framework known as Modern Portfolio Theory. His work focused mainly on portfolios built from the two major asset classes: publicly traded stocks and publicly traded bonds.

Markowitz showed that investors could build better portfolios by combining these two types of investments rather than relying on just one asset class. Because stocks and bonds do not always move in the same direction at the same time, blending them can improve a portfolio’s overall risk-return profile.

In simple terms, an investor who applies this idea to portfolio construction can aim for the best possible return for a given level of risk. This idea caught on and has shaped professional investing for decades.

Alternative Investments: A Third Asset Class

Over time, a third broad asset class emerged: alternative investments, often called “alts.” This category includes equity in private companies, debt in private companies, hedge funds (which often use short selling) and derivative strategies (which often use call or put options). Alts as an asset class offer a differentiated risk-return profile. As such, they pair well with bonds and stocks and can enhance most portfolios.

Historically, however, alternative investments were almost exclusively used by large institutional investors such as pension funds, sovereign wealth funds and ultra-high-net-worth individuals. That is because they often came with high minimum investment amounts, limited disclosure and restricted liquidity. These features do not resonate well with the general investing public, but newer developments have changed things.

Liquid Alternatives

The arrival of liquid alternatives, or liquid alts, has made this third broad asset class easier for all to access. Today, many alternative strategies are available through mutual fund structures that offer daily liquidity, daily pricing, smaller investment minimums and reporting similar to traditional mutual funds.

With mainstream availability, liquid alternatives offer a distinctive risk-return profile that we feel can enhance the diversification and the performance of most portfolios.

A Sample Liquid Alt Strategy

Many liquid alternatives use derivatives: financial contracts whose value is tied to an underlying investment, such as a stock. Used carefully, they can change how a portfolio behaves in different markets.

Dynamic Funds’ Premium Yield Plus Fund is one example. It uses derivatives to earn a regular stream of income from a portfolio of stocks and holds a cash position alongside them. Its results depend on what markets do:

• Markets rise or stay flat: The fund keeps its income and earns a steady return.
• Markets fall modestly: The income cushions the decline.
• Markets fall sharply: The fund loses money, though generally less than the stock market.
• Markets rally strongly: The fund lags because it gives up some upside in exchange for income.

The result is a smoother ride. Historically, the fund’s volatility has been lower than that of the broader stock market, and it targets returns in the high single digits.

Is It Right for You?

Liquid alternatives are not right for every investor, and the right allocation depends on your goals, time horizon and income needs. If you would like to discuss whether they belong in your portfolio, call or email our team, or raise it at your next review.

Warmest regards,

Moore-Miller Investment Group