Alternative Assets

Investments for a Post-Crisis World

Guy Fraser-Sampson

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9780470661376
• eBook ISBN: 9780470980088
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

The investment landscape has changed dramatically over the last few years, destroying many of the old certainties by which investors lived their lives. In particular, it has shaken belief in the ability of traditional asset types such as bonds and equities to protect them from abnormal market conditions, and it has brought home how closely correlation between different markets can be squeezed together by extreme pressure.

Future investors will have to regard so-called "alternative" assets as essential elements within their portfolios, and be prepared to deal with the complexities that this will entail. This will in turn force a re-appraisal of core concepts such as "risk" and "return", not least because some alternative asset classes do not lend themselves well to traditional return measures. Exciting times lie ahead, but a thorough working knowledge of the various alternative asset classes will be an essential pre-requisite to success, and perhaps even to survival.

Alternative Assets meets investor's need for a guide on where to allocate in this new climate. It provides investors with a primer on each alternative asset class, as well as practical tips on the pros and cons, implementation, returns analysis, fees and costs. It also offers introductory guidance on how to set investment targets, and how alternative assets can be accommodated within the allocation process. Each chapter gives useful background knowledge on a particular asset type, including a discussion of whether a satisfactory beta return level exists and, if so, the different ways in which it might be accessed.

Written by best-selling author Guy Fraser-Sampson, this book guides investors through the new look alternative investment arena, providing post-financial crisis perspective and investment advice on the alternatives landscape.

Chapter 1

What are Alternative Assets?

The world of finance and investment is full of unfortunate terms and phrases. Unfortunate in that they are unclear, unfortunate in that they may actually be used in different senses in different situations, or unfortunate in that they evoke emotional responses which may not in fact be justified in the cold light of day. “Alternative assets” is one such term.

Dictionary definitions of “alternative” as a noun range among the following:

• “something different from”;
• “able to serve as a substitute for something else”;
• “either one of two, or one of several, things or courses of action between which to choose”.

Yet the conjunction of “alternative” with “assets” suggests that it is here doing duty as an adjective (qualifying a noun, for the grammatical purists out there), in which cases dictionary entries would include:

• “different from and serving, or able to serve, as a substitute for something else”;
• “of which only one can be true, or only one can be used or chosen, or take place at any one time”;
• “outside the establishment or mainstream, and often presented as being less institutionalised or conventional”;
• “ecologically sound and/or more natural or economical with resources”.

In other words, as a noun “alternative” seems to be capable of at least three meanings, and as an adjective of at least four, which might be summarised as: “serving as a back-up”, “mutually exclusive”, “unconventional or non-traditional”, and “green” (in its socio-political meaning). Of these, at least three are unhelpful, the first two in particular. There is no suggestion that we should invest in alternative assets instead of something else, or that they represent a mutually exclusive choice so that we may invest only in alternative assets. In any event, in neither case would we be able to make any sense of the situation unless we knew instead of what; what might the other alternative or alternatives be?

It is the third meaning that we are going to have to adopt, and yet even here we must be careful, for this usage would include overtones of being marginal, or even downright cranky such as when used to describe alternative medicine. Roget’s Thesaurus, for example, offers “conventional” as an antonym, and “unorthodox” and “unusual” as synonyms. It is perhaps these overtones which can give weight to the pejorative resonance with which the phrase “alternative assets” is often uttered.

It is not even particularly helpful to look at the way in which the phrase is used in practice by investors, since there seems to be no common agreement on this. People can agree on examples (private equity, hedge funds and real estate (property), for example) but not on a universal definition. There seem to be at least three different ways in which the phrase is used to distinguish certain types of assets.

Illiquid

Many say airily “oh, alternative assets are illiquid. You know, not like bonds or equities – illiquid.” However, this possible definition runs into trouble straight away.

For a start, not all bonds and equities are liquid, or at least not all the time. Anyone who may have tried to sell even good quality US corporate bonds in September 2008 will appreciate the force of this comment all too well. However, let that go. The definition still does not work.

Active currency rates are an alternative asset, and what could be more liquid than currency? Similarly gold, which many rightly regard as the ultimate defensive asset. Why? Precisely because one can take it anywhere in the world and turn it instantly into cash. In an Armageddon-type scenario one could even use it as a unit of purchasing power in its own right. So here are two “alternative” assets which we can identify straight away as being arguably even more liquid than bonds and equities.

Unquoted

This definition too runs onto the sandbanks as soon as we set sail in it. It is true certainly that private equity funds, or at least the limited partnership variety, are unquoted. However, all the commodities are “quoted” in the sense of having a price which is available for trading on public markets from one moment to another, as are energy assets, such as oil and gas, and of course currencies. We should also note, without necessarily having to pursue the point further at this stage, that adopting this definition would create some serious ambiguities which it might prove very difficult to resolve. How would you classify 3i, for example? As a private equity fund, or as a public company and major constituent of the FTSE 100 index?

Not Bonds or Equities

I have never heard this definition suggested, save in my own investment modules and workshops, but it seems to me to do the least violence to the situation, since it is both more difficult to attack linguistically and a closer fit for the instinctive attitude of most investors towards such assets. Certainly, one often sees a portfolio divided between “fixed income” (bonds), “equities”, “cash” and “alternatives”.

However, even here there are problems. For example, many investors include “real estate” (property) as an asset class in its own right and then have an allocation to “alternatives” alongside it. Some others include private equity within their allocation to “equities”. There are even some who argue for a still more restrictive definition, which would only cover what one might term “exotics” or “collectibles” such as musical instruments, paintings, etc.

This is one of those situations where no sizeable group of people are ever going to agree on a common solution. It is, however, submitted that “not bonds or equities” is less open to debate than any of the other candidates, and will therefore be adopted for the purposes of this book.

Are Alternative Assets Really “Alternative”?

This may seem like a really pointless question to be asking, the posing perhaps of some arcane academic distinction, but it is not. On the contrary, it exposes a very serious and controversial issue.

The fact that these assets are commonly referred to as “alternative” reinforces the view that they are somehow peripheral to the whole business of investing or, even worse, that there is “proper” investing and “other” investing. “Proper” investing being of course bonds and equities, which should occupy the bulk of your time, and “other” being what you might take a quick look at if you have the time once the main business of the day is done. In other words, that alternative assets are somehow inferior to bonds and equities, which might be thought of as “mainstream”. It would be unthinkable, under this view, for anyone to invest only in alternative assets, since they become by definition something extra which one goes in for only if one has the time and inclination after first setting one’s allocations to bonds and equities.

With very few exceptions indeed, this worldview flows over into actual asset allocation in practice; it is for precisely this reason that we should take this issue so seriously. An automatic or unconscious assumption is being made which is capable of skewing decision making very badly indeed.

It became briefly fashionable during the dot com bubble to talk about “a whole new paradigm”, or “a paradigm shift”. By this was meant that as a result of the information and communications revolution brought about by the advent of the internet, a completely different belief system had come into being, and that it was necessary for finance and investment thinking and practices to be brought into line with it. Should you, for example, be so square and un-hip to ask how a business with no prospect of earnings for many years could be worth several hundred million dollars, you would be met with a pitying smile and the news that “you just don’t get it, do you?”

In fact, at the risk of being thoroughly un-hip, the use of the word “paradigm” was probably itself misguided. As used initially by Thomas Kuhn in his book The Structure of Scientific Revolutions,1 it was confined to the scientific community. It was a system of scientific beliefs, and scientific only. What the internet pundits were talking about was actually not a paradigm at all, but an episteme.

An episteme, a concept coined by the flamboyant French thinker Foucault,2 is a system of thought which embraces all aspects of culture and society, not just science. It also embraces the concept of “zeitgeist”, the spirit of the times. In the sudden readiness of consumers to make purchases online, for example, we see not a new paradigm but a new episteme.

One of the features of an episteme which Foucault identifies is this very issue of unconscious assumptions. In the field of literary criticism, for example, Foucault’s work had a huge impact, as people realised that it was impossible properly to analyse or comment upon a book without understanding the episteme within which the author lived and worked.

There is for example a very early Hitchcock film called Murder, made in 1930 starring Herbert Marshall and based upon a novel by Clemence Dane and Helen Simpson. It does indeed feature a murder, the title being a bit of a give-away here, the motive for which, it transpires, was blackmail. The information in respect of which the individual concerned is being blackmailed is that he is of mixed blood or, as he is dismissively described in the film, “a half-caste”. A modern audience of course finds this incomprehensible. Many people today are of mixed race, and the fact that somebody is would not excite even comment, let alone prejudice or disdain. Yet we are not living in the 1920s and 1930s as the authors of the novel and the original audiences of the film were respectively. Clearly things must have been viewed differently in those days or there would be no point to the film, and Alfred Hitchcock was not the sort of man to make a film which had no point to it. So, it must have been the case that the prevailing episteme of those times included the unconscious assumption, no matter how incredible and objectionable it may seem to us today, that to be of mixed blood was somehow to be inferior, undesirable or untrustworthy, and certainly not the sort of cad to whom one might wish one’s daughter to get married.

So, let us be aware of unconscious assumptions, and of the very important part which they can play.

For, just as with films and literature, we cannot properly understand investment practice unless we understand the episteme within which it takes place, since this will colour instincts, reactions, thoughts, discussions and decisions alike. It is here that we encounter the real problem with the word “alternative”. While this is difficult precisely to articulate, it is part of a system of unconscious assumptions which includes elements of being “more difficult”, “more risky”, “dangerous”, “cranky”, “optional” and “unnecessary”. No better evidence is required of all this than the very low allocations made to alternative assets relative to bonds and equities, at least outside the US.

The view is very much that bonds and equities are essential, while everything else is an optional extra, and quite possibly an unnecessary luxury. This has led in turn to some dramatically undiversified portfolios, particularly among pension funds who, ironically, are often the only class of investor actually to be under a legal duty to diversify their assets.3

The reader should therefore be aware that alternative assets in general are subject to a great deal of unconscious prejudice, and that their supporters are required to justify them both constantly and in great detail in a way which is never demanded, for example, of quoted equities.

At the other end of the scale, there are very few institutional investors who have eagerly embraced alternative investments as a source of diversification across asset classes which hopefully offer lowly correlated returns. The Yale Endowment probably enjoys the highest profile of these, and in recent years alternative assets have generally totalled about 65% of their total asset allocation.4 If only for this reason, the question which serves as the section heading is clearly relevant and valid. If alternative assets can make up about two thirds of the portfolio of one of the best investors in the world, how can they really be said to be “alternative” at all?

Thoughts on Classification

Having established that we are going to assume that any assets other than bonds and equities can be “alternative”, let us see if we can identify some different asset types, and consider how we might further discuss, and possibly classify them.

First and most obviously, if we are going to say that bonds and equities are not “alternative”, then what about things which are not bonds or equities and which yet represent them, such as futures, options and swaps positions over individual bonds or stocks (shares), or groups or markets which include them? There is a yet further complication here, of course, since hedge funds routinely deal in such instruments, and yet by most people’s reckoning are firmly in the “alternatives” camp.

It is probably best to treat these not so much as an asset type as a way of investing, a means rather than an end. They are thus an investment technique, or a means of replicating or synthesising a particular investment, rather than the investment itself. As we will see, it is in fact often the case with the asset types which we will be considering in this book that synthetic coverage of this nature is the only practical path to take.

Private Assets

On one view, alternative assets fall for the most part rather neatly into two separate categories, but with Hedge Funds hovering uneasily with more of their weight on one side of the line than the other.

Many alternative assets are publicly quoted and highly liquid, thus making it rather difficult to see what is really so “alternative” about them at all. Commodities, energy, gold and currency assets all defin...

Table of contents

• Cover
• Half Title page
• Title page
• Copyright page
• Preface
• Acknowledgments
• Chapter 1: What are Alternative Assets?
• Chapter 2: Investing in Alternative Assets
• Chapter 3: Real Estate
• Chapter 4: Energy
• Chapter 5: Private Equity
• Chapter 6: Hedge Funds
• Chapter 7: Infrastructure
• Chapter 8: Commodities
• Chapter 9: Gold
• Chapter 10: Active Currency
• Chapter 11: Other Alternative Assets
• Index
• Wiley End User License Agreement