Inside the alternative investment universe

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22 August 2003
| By Craig Phillips |

For many financial planners the term ‘alternative investment’ implies an asset allocation to a hedge fund, however, this particular investment vehicle is only one of the many forms of investing within the alternative universe.

Apart from hedge funds, other less traditional forms of investing include private equity, infrastructure, unlisted property and various hybrid products.

Private equity is arguably the most common form of alternative investing behind hedge funds, however, it remains predominantly a wholesale investment vehicle. Private equity covers pre-seed funds (which tend to be launched through government initiatives), early stage funds, expansion stage funds, later stage funds, management buy-outs/ins and leveraged buy-outs.

The risk/return profile of each type of fund varies, as investors in funds that focus on start-up companies and technology are exposed to a greater degree of risk than those entering a fund later when the investments within it are more mature and offer a greater degree of investment return certainty.

However, according to alternative asset consultant firm Quentin Ayers executive director Gary Lines, funds in Australia tend not to specialise in any one stage or type of investment because the domestic market is not big enough to allow for this.

Lines also reveals that 75 per cent of the Australian private equity market is only accessible to wholesale investors because managers draw down investment pledges from clients on a ‘just in time’ basis.

“Managers only ask for the money when they have found a suitable deal. Having an institutional client that can write a large cheque in a matter of days therefore gives private equity managers more certainty than if they had to approach numerous mums and dads for the same capital,” Lines says.

A variety of debt-based offerings, such as distressed debt and collateralised debt obligation products, also fall under the umbrella of alternative investments.

“Distressed debt is always an interesting one, it’s about trying to pick up companies that have either gone into bankruptcy or are about to go into liquidation and trying to buy their debt very cheaply,”Schroder Investment Management Australiainvestment director Greg Cooper says.

“Basically what you’re buying it for is not a yield, as quite often they’ve already defaulted. You’re just trying to pick up the capital gains through the restructure of the company.”

Cooper argues that distressed debt investing tends to be cyclical because it is largely influenced by the economic cycle — when more companies default there are often more distressed debt opportunities.

According toBerkley Group Funds Managementinvestment manager Gabriel Radzyminski, in the US, distressed debt tends to fall into the event-driven hedge fund category.

“One of the differences between distressed debt domestically and internationally is that in the US there tends to be a very large liquid market through a large junk bond market. In Australia, however, it tends to be more illiquid and is therefore treated as more of a private equity investment,” he says.

Collateralised debt obligations (CDOs) on the other hand, are asset-backed securities on a diversified pool of financial assets such as high yield bonds, leveraged loans, emerging markets debt and so on. CDOs involve multiple classes of notes or tranches being issued, with the purpose of allocating credit risk and expected return according to the risk-return preference of investors.

In the case of infrastructure, Macquarie Bank head of infrastructure and specialised funds Anthony Kahn suggests this mode of investing is actually becoming a mainstream asset class by itself.

“Infrastructure is moving from an alternative asset to a mainstream asset. A lot of people are now looking at it and are prepared to look more long-term, given the economic environment of low inflation and interest rates. It’s unlikely to become as abundant as equities or bonds, but it’s certainly becoming more popular,” he says.

Kahn says the difficulty facing managers is the challenge of sourcing quality of what are in essence scarce assets.

“Infrastructure investments offer a strategic competitive advantage as they often have large fixed costs and are difficult to replicate. So any increase in patronage, for instance, people passing through an airport, is likely to lead to greater returns,” Kahn says.

Radzyminski believes unlisted infrastructure is well positioned within the existing business climate.

“There are a lot of good opportunities on the unlisted side, ranging from things based on capital growth to income producing investments, which provide a running yield,” he says.

However, Kahn says there isn’t too much difference between listed and unlisted investments because they both offer a steady cash flow to investors in the form of stable revenue.

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