Alt Investments
The Promise, Complexity Of Alternative Investments - An Overview
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This article starts a series about how wealth managers and clients should think about alternative investments.
Family offices are investing in private debt. Technology geeks
are coming up with ways to commoditize diamonds. Despite
widespread reports of their demise, hedge funds won’t die and
keep on going. Welcome to the diverse world of alternative
investments.
The very word “alternative” creates a problem because some areas
covered by this term, such as property and commodities, aren’t
very alternative - they are assets that have been around for
centuries, long before anyone heard of listed equities or
corporate debt. (Even the ancient Greeks had a sort of futures
market in olive oil.) To some extent the term arose to cover all
those activities that were not stocks, bonds and cash. For some
observers, another way to nail down a definition is to think of
illiquid versus liquid (ie easy to buy and sell). That is not
always ideal, however, because some commodity markets are very
liquid.
Another possible marker is that such assets have a number of
distinct qualities. Agricultural commodities, such as wheat,
coffee and sugar are heavily affected by specific aspects of
nature, most obviously the weather. Venture capital investments
require an often deep and laborious understanding of companies,
managers and sectors. Precious metals bring up not only the need
to understand the economics and finance of mining, processing and
distribution, but also geopolitics and central bank tactics.
A more wry definition of an alternative investment is
“something that uses leverage and charges hefty fees”.
Alternatives have become part of the standard vocabulary of
wealth management. Part of the promise of these assets is that
they are supposed (so advocates say) to offer genuine
diversification in a portfolio. This is a fraught area because
much depends on the time period one is considering. Take gold,
for instance – this supposed “safe haven” asset can sometimes
move in lockstep with bog-standard equity markets in times of
stress because investors, desperate to meet leverage limits (aka
margin calls), can dump valuable assets such as gold to raise the
money they need. (This happened in 2007 around the time that Bear
Stearns and the UK’s Northern Rock hit trouble. Remember them?)
Over the longer term, correlation relationships can change – but
for some investors, they could be out of the game in the “long
term”. Private equity, VC, private debt and forms of real estate
can sometimes follow a different path from, say, the S&P 500
or developed countries’ debt markets. But to achieve that
diversification requires a price: the higher fees one pays for
private equity, for example, and the lower liquidity and longer
holding periods, and the need to learn the complexities of the
asset classes.
Getting a seat at the table
For all the debate about the value of alternatives, one big
change is that investors have more ways to get a seat at the
table than two decades ago. Take hedge funds: once only big
pension and life insurance funds had a chance to ride along with
the best managers. Now new platforms and placement channels -
Mercury Capital Advisors, iCapital Network and CAIS, to give just
three - are to some extent “democratising” access. And
inevitably, blockchain technology opens the route of “tokenising”
investments into areas such as private equity where investors
only put in a fraction of the money they used to be asked for.
(Examples include Xen Technologies in Asia and the Swarm Fund in
the US.) Instead of $1.0 million to get into the game, tokenised
investors might only need to put in $100,000. There are also
listed vehicles that invest in private equity and other areas –
“liquid alternatives” - for example, so the investor can tap into
the sector by buying and selling a company’s shares. (This does,
however, create a problem when the share price of such a
structure trades at a significant discount to the entity’s net
asset value.) In fact, liquid alternatives have been boosted by
the advent of cross-border fund structures such as Europe’s UCITS
market. A point to note, however, is that investors and advisors
must understand that the promise of daily liquidity in such a
fund may not fit with the underlying assets and
strategies.
Regulators, mindful of the need to stop mis-selling and providing
unsuitable products, generally tend to limit access to
alternatives to professional/”sophisticated” investors. The
boundaries can be fuzzy. There is also a broader policy concern
here. If alternative assets are so valuable, why should only the
seriously rich or big institutions get a piece of the action?
Should we not go with the idea of “let the buyer beware?”
Property in all its forms is a whole story of its own, both part
of the “alternative” space but also one that any householder can
relate to. The past two decades have seen the ascent of Real
Estate Investment Trusts (REITs) in several jurisdictions, such
as in the UK. But funds and pooled vehicles are only a part of
it. Family offices are directly investing in some major
properties and excluding the intermediary completely – this is a
big trend. Another theme is club-deal property investing.
Property, being a highly “political” asset, of course, tends to
also have tax peculiarities, as well as considerations such as
planning consent and land use control.
Organisations such as Preqin, Hedge Fund Research and Cambridge
Associates provide much more detail on these asset classes.
Preqin, for example, churns out reports on fund-raising, exits,
rates of return, sector and regional analysis. And some of the
terminology, which in the past might have made these areas
mysterious, is becoming mainstream financial vocabulary. (As an
example, take the idea of internal rate of return, which tries to
measure results amid the complex entry and exits from deals).
Some of the vocabulary can still befuddle the uninitiated, such
as “mezzanine capital”, or “merger arbitrage”. The industry must
be ruthless about explaining what it does clearly.
Such an overview can only scratch the surface. There is also the
whole beguiling area of collectables – fine wine, classic cars,
fine art, watches or ceramics. These blend investment and hobbies
and are relatively small compared with the multi-trillion
financial markets of today, although for obvious reasons they
gain a lot of attention.
In coming days we will issue interviews with practitioners on the
alternative investments space and hope readers find them
illuminating. And who knows, one day the industry might even come
up with a different moniker from “alternative investments”.