By Mike Horseman, Managing Director, Cockburn
Lucas
Until now, these alternative assets have been denied to mainstream
investors due to a combination of well intentioned over-regulation, lack of
investor demand due to perceived complexity and scarcity of suitable products
that allow easy, efficient access at a reasonable price.
Consequently,
assets such as hedge funds, structured products, private equity, overseas
property, commodities, microfinance and even art and wine investments typically
have been the preserve of institutions and private banks, but attitudes are
changing fast and it will pay to do your research.
The reason why such
assets have found favour with high net worth clients over the past few years is
their propensity to enhance the risk/reward characteristics of an investment
portfolio. Most of us appreciate that holding a single asset exposes us to the
risk that we are ‘putting all our eggs in one basket’, so, clearly, spreading
our investments across different assets would appear to be the way to avoid
this.
But there is a note of caution here; it is not that the assets
chosen need to appear different, but that they must actually behave differently
to each other in terms of both risk and return profile, demonstrated by
correlation, which must be weak, or preferably 0. The investment industry has
created a term for naïve diversification where assets appear to be different,
but actually behave very similarly and it is Diworsification, which is to be
avoided at all costs!
Common problems arising with alternative assets
are that they are often hard to find, have low liquidity, high fees, onerous
redemption clauses, lack of transparency and are often outside the FSA’s
jurisdiction.
Many of these issues are insurmountable; however, it has
become slightly easier, due to the use of investment trust structures to house
alternative assets inside client portfolios, as these are legally listed
companies. Also, the advent of UCITS III has bought with it the ability of
retail OEICs to be able to use certain hedge fund techniques and instruments.
This is to be applauded, as genuinely talented managers with flexible mandates
will be better able to offer investors their true desire of absolute, rather
than relative, returns at reasonable cost.
There are issues that arise
with increased complexity; not only does it become harder to judge whether
managers are competent enough to be able to use such flexibility, but it also
raises the question about the adviser’s ability to be able to truly understand
the risks that their clients may be exposed to and to explain those risks at
outset. The investment industry will surely take up the challenge of educating
those that show an interest in alternative assets and complex investment
strategies, but, so far, the silence has been deafening.
Meanwhile, one
of the huge successes of 2008 has been the BlackRock UK Absolute Alpha fund,
expertly managed by Mark Lyttleton, who has delivered strong absolute returns
and attracted a lot of assets using a strategy very similar to a market-neutral
hedge fund. This shows how retail funds are beginning to blur with alternative
strategies.
It is also clear that other products will be launched trying
to achieve absolute returns; some will be successful, but history warns us that
many will disappoint. I recall a number of Bond funds boasting unconstrained
benchmarks and target returns of LIBOR + 2% were the new way forward in
fixed interest management some years ago; however, one look at the UBS absolute
bond fund or CSAM target return should act as a sobering reminder that new
techniques need the people behind them and it is worth paying for talent.
The question is, do advisers truly believe that they will able to choose
between alternatives and have the time to carry out due diligence within this
space on individual alternative asset funds?
The answer cannot be to
avoid all complex, yet favourable investments, as this would be doing a
disservice to our clients. Surely, the benefits of adding proper diversification
warrants advisers furthering their knowledge to be able to confidently select
appropriate assets, or if this is not possible there is always the option of
outsourcing to funds that are able to do this on behalf of the adviser.
Offerings such as the Cazenove Multi-Manager Diversity fund and Insight
Diversified Target Return spring to mind, as both have a strong record of
investing across a variety of Conventional, but with at least 30% of alternative
assets and a highly rated team with resources to boot, which should enable a
peaceful night’s sleep for both the adviser and client.
11 June 2008