Friday, June 01, 2007

Horlick: ‘Stand by for something seismic’

Let’s cut to the chase: alternative assets are entering the mainstream. What we are about to witness is nothing less than a seismic shift in asset allocation.

The Financial Services Authority is nearing the end of a period of consultation during which it has been considering whether retail investors should be allowed access to alternative investment funds. And APCIMS is altering its three principal private client indices to include a weighting to hedge funds and property at the expense of traditional asset classes.

It is interesting that the very wealthy are way ahead of the game and have been investing substantial sums in alternative assets for many years. We have seen high net worth and ultra high net worth individuals increase their allocations to alternatives from 10 per cent in 2002 to a forecast 22 per cent or more this year.

In the institutional market place, UK pension funds have been slower than their international counterparts to see the advantages of diversifying their portfolios through investment in alternatives with an average of 3 per cent typically allocated to these assets against a typical 22 per cent in Switzerland and 14 per cent in Germany, for example. But, even here, there have been some high profile examples of change with the BT pension scheme, managed by Hermes, leading the advance. Last September the scheme announced it would be allocating 13 per cent of its scheme to alternatives in the short term and 15 per cent in the longer term. At the beginning of May, it was reported that BT had delivered a return that was two percentage points higher than the average achieved by the UK’s top 50 pension funds in 2006, so its more open-minded approach seems to be making a difference already

Across the pond, Yale University’s multi-asset endowment fund, acknowledged as the trail-blazer in this field with a two-thirds portfolio allocation to alternatives, has produced net annualised returns of 16 per cent over a twenty-year period – consistency that is attributed entirely to its readiness to include alternative investments in its asset mix.

So what is behind this change? Diversification is a key driver. Another reason is the returns on offer. Take hedge funds, where the Credit Suisse Tremont Index five year cumulative return of 64 per cent compares with a return of 35.5 per cent from the S&P 500 index (as reported on 1st April 2007). Then take private equity funds, which have returned 18.7 per cent annually, net of all costs and fees, compared with the 7.3 per cent returned by the FTSE 100 Index over the ten years to December 2006, according to the British Venture Capital Association.

Demand for assets at the speciality end of the scale such as fine art, timber, infrastructure and leveraged property funds remains strong because, here too, the outperformance is frankly worth having.

It is entirely likely that within a short period of time, say 12-18 months, mass affluent private clients will have 10-15 per cent allocation to alternatives. The more analytically-based discretionary managers have for some time been allocating a minimum 5 per cent to alternative assets in even the most cautious investment portfolio. Why? Because diversification equals less risk and the returns from these asset classes are extremely attractive.

There is no doubt that portfolio allocations must and will adapt to include a weighting to alternatives. This transition is going to happen quickly, leaving advisers scrambling to find suitable products they feel able to recommend to their clients.

But they should be aware of mounting evidence that there is a huge discrepancy in the returns delivered by the top and bottom quartile private equity funds. One reputable study found this discrepancy to be an annualised 23 per cent return from the top quartile and 4 per cent from the bottom quartile funds. The overwhelming message that this statistic delivers is that smaller investors must find a way to invest in the top tier funds.

Nicola Horlick

Ms Horlick is chief executive of Bramdean Asset Mangaement

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.