Alternative point of view

private equity asset class advisers hedge funds interest rates retail investors

30 January 2015
| By Staff |
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Although the start of the new year may seem much like a continuation of the past one, those paid the big bucks to monitor the heartbeat of the market believe a new rhythm can be detected.

Joseph Amato, president and CIO of Neuberger Berman, puts it this way: "In 2015, we see central banks and growth rates of the major developed economies moving in different directions. Although the long-term trend for global growth appears positive, we anticipate variable market performance as investors come to terms with new economic realities across global markets."

These changing dynamics are likely to see new winners and losers. As State Street Global Advisors' (SSgA's) Global Market Outlook for 2015 notes: "Diverging global monetary policy and interest rates will impact almost every asset class in 2015."

Increased equity market volatility due to a move away from synchronised central bank monetary policy is ushering in greater market volatility, something that is music to the ears of many alternative asset managers.

According to James Langlands, head of retail business at BlackRock Australia, the argument is persuasive. "We saw some volatility at the end of last year and expect the same again this year, which is a classic case for alternative investments," he explains.

"If you look on the surface, the case for alternative assets looks very strong, as the valuation of traditional asset classes is reasonably full and those that are cheap — such as Russia — are cheap for a reason."

Investment managers like Langlands believe alternative assets are an important tool for advisers looking to diversify equity-heavy client portfolios and find alternative sources of return.

"At the back of the GFC advisers were asking what to do with their clients' money and we are seeing the same thing now. Fuller equity valuations are making allocations difficult and advisers are again asking where future returns will come from," he says.

Time for alternatives to shine?

Alexander McNab, CIO of Blue Sky Alternative Investments, agrees investment conditions are very positive for alternative investments.

"There is a whole bunch of macro factors such as the unwinding of the resources boom and low consumer confidence domestically, while internationally there are concerns about Greece and the Eurozone and the falling oil price which will make things difficult," he explains.

"We think markets are priced with a high degree of optimism, but the downside risks are definitely there."

This type of environment is one where alternative assets could be expected to shine.

"The next six months may be where the performance of alternative funds diverges from that of the broader market. If everything achieves a 15 per cent return nobody notices alternatives, but if they achieve a 15 per cent return and the market tracks sideways or down, then the value of an alternative allocation will be even clearer," McNab argues.

According to Langlands, the relative case for alternative investments is "very strong" and he believes the emergence of appropriate investment conditions will feed the recent uptick in interest by sophisticated advisers.

"Now the market cycle looks like it has got ahead of the business cycle, more advisers are interested. Also, the traditional ways of investing for clients — such as 70/30 — are not as good a diversifier as in the past. This is especially the case with fixed interest, and particularly fixed interest in Australia," he says.

Although solid returns are important, BlackRock believes adviser interest in potential sources of diversification is a significant driver of the renewed attention being paid to alternative assets.

"Fixed interest is less attractive as a diversifier for the fuller value equity portfolios advisers are holding on behalf of their clients," Langlands explains.

Hedge funds looking up

With higher volatility returning, looking for ways to manage the downside equity risk present in many client portfolios is increasingly important for many advisers.

New York-based David Kupperman, managing director at Neuberger Berman and senior member of the investment team for the firm's Absolute Return Multi-Manager Fund, believes several popular hedge fund strategies will be well placed to shine in the current climate.

"We have positive views on event driven strategies. We are bullish in this area as a lot of cost-cutting has been undertaken and growth remains slow, so the best opportunities are in different types of events. We think this will continue for the next 12-18 months," he notes.

"In the long/short space, stock correlations have come down, making it easier for stock pickers. Also, it is easier to short, as balance sheets can no longer hide debt and refinancing issues, so we think these strategies have a favourable outlook."

Some strategies will be better able to capitalise on the new investment environment than others, so careful selection will be important, Kupperman says. "Different hedge fund strategies will perform in different environments."

Langlands agrees some hedge fund strategies are well positioned to take advantages of the new opportunities on offer this year. "In the hedge fund area, the market neutral, long/short equity and diversified market neutral multi-asset strategies all look interesting."

Although the influence of central banks remains key, the different growth outlooks appearing among the major developed economies may give global macro managers the chance to demonstrate their capabilities.

"There has been a change of view to positive on global macro strategies, as over the past few years central banks have had a unified approach to interest rates, but now we are seeing a differentiated policy. This is leading to a dislocation in approaches by central banks and there are opportunities," Kupperman explains.

"We are not allocating as yet, but we are evaluating and continually assessing different strategies."

Hedge funds focussed on strategies around distressed assets also looking appealing, although low default rates are making life more difficult for managers. "We like distressed strategies and think they are interesting. However, it is not as much a slam-dunk as it was, so we have a neutral rating," he says.

Private equity robust

The private equity and venture capital market both here and overseas also look positive. In the US, Neuberger Berman's 2015 Outlook report noted: "The growth equity sector remains underserved and thus offers attractive return potential in our opinion, [while] the secondary market seems likely to continue its long-term growth trend."

Closer to home, although deal activity last year in the private equity market was lower than the previous financial year in terms of total deal size, deal numbers were up, according to new research by the Australian Private Equity and Venture Capital Association. According to AVCAL chief executive Yasser El-Ansary, the outlook for this year is good: "Higher Q4 2014 fundraising levels and deal activity suggest a positive 2015 outlook."

Despite the optimism, Langlands is cautious about private equity, seeing it as reasonably fully valuated at the moment. "The market has not peaked yet, but investors need to be selective. Caution is needed when private equity funds are buying public equity, as that shows there are some frothy valuations."

McNab agrees there are risks for investors. "The private equity space has the highest correlation to equities. Managers with a defensive positioning will perform better than those with lots of leverage to consumer discretionary."

Hunt for yield affecting valuations

When it comes to infrastructure, caution is again the watchword for Langlands. "The infrastructure story is interesting and there is a wall of money needing yield. It is one of the areas that looks interesting, but the question is are you being compensated for locking up your funds for the long-term? We would encourage investors to avoid greenfield and riskier investments, and maybe go for brownfield or established assets."

McNab is much keener on this sector. "We have a high degree of conviction towards real assets such as infrastructure and agriculture (which includes assets such as water entitlements), and view it positively. We were sceptical about values in the infrastructure sector as it is tied to a low interest rate environment. But now low interest rates appear to be here to stay for longer than previously thought, our view has shifted."

Despite its appeal as a ‘real' asset and strong return performance in recent years, the continuing ‘hunt for yield' by investors around the globe is causing problems when it comes to property valuations.

"In property you are seeing some inflated valuations in many areas around the world, due to income-seeking investors. There are some areas of interest, but investors need to be careful," Langlands notes.

Interest among retail investors

While new global research by SSgA indicated institutional investors have an increasing appetite for alternative investments such as hedge funds, infrastructure and direct loans, retail investors are also taking a fresh look at the asset class.

"In the US market we have seen increasing interest by retail investors as these assets are more accessible now," Kupperman says.

According to McNab, efforts in recent years to educate advisers about the benefits of alternative assets are now starting to pay off, with some starting to follow the lead of institutional investors in making allocations to the asset class. "In the past 18 months, we have found the awareness is now there among many advisers. A small group of sophisticated advisers really see the value of alternative investments, but the problem has been access."

Langlands agrees: "Among sophisticated advisers, we are seeing increased allocation at the moment at the margin."

The central role played by platforms in most advisers' businesses and the need for daily liquidity have stopped broader take-up of alternative investments, McNab says. "In many cases this structural impediment has stopped advisers from investing."

Last year's launch by Blue Sky of Australia's first listed investment company (LIC) based around diversified alternative assets may the catalyst to change this.

"Advisers provided the idea for the LIC to give them with a way to access alternative investments," McNab claims. "It gives them daily pricing and liquidity and allows smaller advisory groups with smaller exposures to gain access to the asset class."

The new vehicle could prove to be the tipping point for the retail sector, he says. "It is opening up alternatives allocations to a whole new group of investors."

Despite the easier access, Langlands believes the retail market remains cautious about alternative investments. "Advisors are still very mindful of the problems in hedge funds during the GFC. They are also conscious of the focus on financial services and the planning industry in the media and regulatory area, so they are looking for diversification in underlying assets, transparency and a long-term track record."

Although easier access may help spur retail interest, he has some doubts. "Potentially it will help as liquidity is a focus, but you don't necessarily get as high a quality of assets in listed vehicles as there is a liquidity premium. At the margin, it may prompt more interest, but it is the market dynamics that are generating more interest amongst advisers."

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