Not every investment has to be in the four classic asset classes of equities, property, bonds and cash.
The combination of market turbulence and exceptionally low interest rates is leading many investors to look at investment categories which might be classified as lying outside the tradition asset classes of equities, bonds, cash, and real assets like property. They tend to look for alternative investments which will outperform inflation but at the same time will not suffer from the volatility of equities, the low returns offered by bonds or cash, or the liquidity issues associated with property.
The best of all worlds, in other words. But there really is no such thing as a free lunch or a sure-fire winner on investment markets.
As a broad category, alternative investments include assets such as commodities like gold, oil, and other metals with which people will be familiar and real assets, such as property and infrastructure including renewable energy developments. It also covers more complex and some would say unconventional strategies such as private equity funds, hedge funds and absolute-return funds.
Alternatives can mean anything from private equity opportunities to venture capital
What investors are seeking is returns uncorrelated with traditional equities, bonds and other asset classes – in other words, they don’t usually move in the same direction at the same time.
“Alternatives can mean anything from private equity opportunities, venture capital, and a range of structured products,” explains Davy head of advisory and execution Gary Connolly. “They can be variants of the four main asset classes but are accessed in different or more flexible ways.”
He points to absolute-return strategies sometimes classed as an alternative and even once touted as a fifth asset class. “They invest in equities, bonds, cash, properties, currencies, and commodities but they are not just betting one way. Traditional view of equities investment is that the investor is hoping the asset price will rise. Absolute return funds can benefit from movement in either direction – they are not long only. That’s probably why they fall into the alternatives category.”
These funds can engage in what is known as short selling where they take positions in the market which allow them to profit from a fall in a stock price. They employ other strategies in an effort to deliver positive returns regardless of the overall direction of the markets. Many of them performed well between 2008 and 2012 but have been somewhat disappointing since.
Private equity funds, on the other hand, have become quite attractive to investors. Connolly explains that the number of publicly quoted companies in the US has halved over the past 20 years due to a variety of factors including the very low cost of capital. “Companies are staying private for longer,” he notes.
Private equity used to be seen as the preserve of ultra-high net worth individuals but is now democratising
This means that equities investors are missing out on the growth potential of a huge number of companies. On the other hand, by investing in the private equity funds which are financing many of these private companies they can get access to that growth. “Private equity used to be seen as the preserve of ultra-high net worth individuals but is now democratising to a certain extent,” says Connolly. “In the US, the law has changed to allow people invest part of their 401K pension funds in them.”
Exposure to renewables
Brewin Dolphin investment strategist Ian Quigley takes a cautious line. “You’ve got to be pretty careful about them,” he says. “We really don’t allocate to hedge funds or absolute-return funds in any meaningful way. Strategies that aim to deliver positive returns while avoiding volatility can often disappoint people as has happened over the past few years. We do invest in some infrastructure strategies which offer exposure to renewables. Some broadly based infrastructure funds can achieve returns of 4 per cent, they are not risk free though.”
Renewable energy investments are proving attractive to Cantor Fitzgerald clients, according to global strategist Pramit Ghose. "We are finding many of our clients looking to invest in the area, which appears to be on a long-term structural growth path. We have helped investors access this growth sector by private equity and loan note investments into wind and solar energy projects. For lower-risk clients, perhaps those looking to move out of low-yielding deposits we are still seeing good demand for investment products that have some kind of capital protection feature. These investment products, such as our Global 85 per cent Progressive Protection Bond, have the potential to deliver a higher return than deposits with limited downside risk."
Bank of Ireland chief investment strategist Kevin Quinn believes they do have a place in portfolios. "There are lots of structured products out there which are very varied. You can have products which will pay out when a certain index or group of indexes behaves in a certain way, for example. Some of them have capital risks and liquidity constraints and some of them have done well. Hedge funds have had mixed outcomes in recent years while private equity has been at the other end of the scale with double digit gains. They have a role to play in a portfolio where an investor is adding them into a mix of the four traditional asset classes."
Ghose sounds a further note of caution. “Private equity investments usually offer above average return potential, generally in the high single- to low double-digit percentage per annum range. They are bespoke and usually only suitable for more experienced investors with higher risk profiles. The investment products that have some element of capital protection generally have low single digit return expectations, as a trade-off for the downside protection.”