Different Strokes

14.12.16

Investors have a tendency to mistakenly consider alternative investments as the sole province of high-net worth individuals and institutions. Not so, as Tom Hearnden of Edenhurst explains

Alternative investment misconceptions are often bandied about. This primarily arises from the inherently complex nature of such an investment, and can quite often lead to a severe reluctance to include them in portfolios. However, the opportunity cost of repeatedly ignoring alternative investments may be fairly substantial.

The global aggressive monetary expansion through quantitative easing, which  has put an end to the 35 year bull market in bonds and brought yields close to zero, has evidently increased the benefits arising from alternative investments. The steady increases in US interest rates should be seen as a positive macroeconomic factor for hedge funds, which have historically performed well during periods of rising interest rates; the HFRI Fund Weighted Composite index returned close to 12% p.a. on average during the past three US rate-hike-cycles. Investors seem to have already integrated such exogenous factors and accordingly adjusted their strategies. Thus, according to research from Willis Towers Watson, the pension fund consultancy, the total value of assets managed by the 100 largest alternative managers rose to $ 3.6tn during the beginning of 2016, a 3 percent increase relative to the previous year. The study showed a heightened interest in private equity, hedge funds and infrastructure from institutional investors, mainly pension funds which remain the largest investors in alternatives (41% of the total assets managed by the 100 alternative managers). The study also revealed that real estate is the most popular asset class for institutional investors; accounting for over a third of the assets managed by the top 100 managers.

Those with a fairly higher risk tolerance, seeking both return and portfolio diversification might be tempted to allocate their assets towards hedge funds or property rather than bonds. For investors with relatively low near-term capital needs, 2017 may be a good year to consider private markets strategies. Indeed, numerous firms, particularly the fastest growing technologies, seem to exhibit some substantial reluctance to go public; the number of US-listed companies has roughly halved since 1996. According to CB insights, there are now globally 177 private companies valued at $1bn or more, meaning that investors are required to gain at least some level of exposure to private markets in order to achieve effective diversification. Furthermore, at turning points in monetary policy, correlations between bonds and equites tend to intensify, substantially diminishing the diversification benefits normally associated with high grade bonds. During time of market uncertainty regarding monetary policy, alternatives provide a return which may be less correlated than bonds and equities.

 

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