The pursuit of market-beating Alpha remains a trend in these low-yield times; Beta-tracking, low-cost products such as exchange-traded funds continue to proliferate. The idea of how one can best combine both approaches and use core/satellite to frame investment discussion formed the theme for a panel debate at the recent WealthBriefing GCC Region Summit November 2014. (To see another item from this conference, click here.)

The event was held at the Mina A'Salam Hotel, Dubai.  The headline sponsor for the event was Jersey Finance; other sponsors were Advent Software; Coutts & Co Trustees; The Left Shoe Company; ProFundCom; Russell Investments; smartKYC; Standard & Poor’s Money Market Directories.

Speakers at the event were Ausaf Abbas, founder of Coombe Advisors; Iheshan Faasee, client portfolio manager, EMEA, Russell Investments; Khurram Jafree, managing director, head of products and services, MENA, BNP Paribas Wealth Management; and Vic Malik, director and regional head of global investments and solutions, Barclays Wealth and Investment Management.

Blending a mix of core and satellite investments can create such a complex pattern of holdings that it can create problems of its own, delegates were told. For example, BNP Paribas’ Khurram Jafree argued that complexity, if it becomes a barrier to explaining investments to the end-user, leads to the danger that such an investment might fall foul of regulators. “You don’t want to make the mousetrap so complex that it becomes a suitability issue if you are trying to explain to the client,” he said.

Another issue is that a variety of different assets is not the same as diversification of risk, unless investors understand where the sources of risk reside. “You can have unintended complexity,” he said, noting that a supposedly diverse set of portfolios can have more cross-correlations than as first supposed. “You are not diversifying at all but doubling your risk,” Jafree said.

Asked about structured products as part of a portfolio offering, he said they have a place and could provide convenient access to particular markets, with varying levels of bespoke and more standard offerings.

What is your pain threshold?
With any debate about how to put investments together, it is key to understand how much damage can be done to a portfolio by some sort of adverse effect, argued Russell Investments’ Iheshan Faasee.

“It ultimately comes down to a question of risk. How much risk is your portfolio going to survive to a satellite then you have to ask what you are trying to do,” he said.

Have rising compliance/regulatory costs deterred people from holding satellites?

“When we look at the amount of flow into hedge funds itself between 2012 and 2013, then across the board, across multiple firms, increases of around 15 per cent…..I don’t think regulation has had too much of a negative impact,” Faasee replied. “Too few people discuss what happened before 2008, the financial crisis of 2007, which was a liquidity-driven one and a lot of regulation was in response to these events.”

Often, demand for liquidity is at the highest when it is least available and when correlations spike, he said.

The road taken
Barclays’ Malik said that the way an investor chooses to access an asset class, such as the investment vehicle, is as important as the asset class itself: “When constructing a diversified portfolio, we ask does the client believes in skill? Clearly, you can build Alpha and Beta together and hold that in a diversified portfolio.”

“It is about investment with conviction as all investments are. The approach we take is to assess not only suitability but how the investor feels about the investment journey. That is critical and it is a point often missed…..what happens if volatility comes and how would the client react,” he said.

Asked about how to think about volatility and risk, Malik said: “Volatility is not ultimately a perfect way to create portfolios.” He also referred to the problems in standard deviation measures of risk. “What we have learned in the past few crises we have been through is that you have got to look at fat tails,” he said.

Several of the speakers, asked about the benefits of structured products in delivering certain kinds of protection or controlled outcome, said there are grounds to hold such products, so long as the client understood them and they were suitable for investors’ real purposes. However, Ausaf Abbas strongly disagreed, with one caveat:  “My advice consistently for the clients I work with is not to buy a structured product marketed by a private bank or wealth manager, because you don’t know why they are marketing it. They can price volatility, clients cannot, and there are multiple layers of fees for the trading desk, for intermediaries and advisors.”

“The only time you should use a structured product is when you have a complex investment idea and you can get a bank to structure it for you, but make sure to get multiple quotes from different providers,” he said.

The second WealthBriefing GCC Region Summit will be held on 14 May at the Mina A'Salam Hotel in Dubai - click here to register your attendance.