A class above; a league of their own;

In the current market turmoil, any investment with the word ‘alternative’ is likely to be avoided by nervous investors.

As alternative investments include hedge funds and infrastructure, many investors are treating these products with complete disdain.

But is shunning the sector fair?

Those working in the sector think investors’ and advisers’ dislike of the sector does not reflect the opportunities that are available.

Lonsec general manager of research Grant Kennaway agrees investors and advisers have lumped alternative investments in with all other sectors.

“I think alternatives have been tarred with the same brush as other investments,” he said.

“They have been struggling but some segments have been doing well.”

Kennaway singled out commodities as a top performer, which is why the perception that alternatives are performing badly is wrong.

“But commodities are hard to access [especially] for the small investor,” he said.

“Advisers need to step back and look at client diversity and select different products that include alternative investments.”

Kennaway said one reason for including alternatives is to diversify portfolios, and it is a good solution to expanding to a broad portfolio.

“Alternative investments are being researched more and advisers can no longer plead ignorance on the sector,” he said.

“Lonsec accepts alternatives into model portfolios using managers such as Select.”

JP Morgan vice president of equity derivatives and structured products David Jones-Pritchard believes the sector has been unfairly treated by investors, particularly structured products.

“I think structured products have been caught up with investments that a lot of investors have lost money on,” he said.

“But we are now seeing investors doing nothing, as they seem to be waiting for markets to go back up again.”

Jones-Pritchard said the attractiveness of structured products in the current investment climate is that the capital is protected.

As a result, with stock markets depressed, these are good products to use to re-enter equity investing.

“It is a good time as the ASX is down 18 per cent and emerging markets are down 13 per cent,” he said.

“There is lots of volatility, which is why people are hesitant. However, with capital protection, it smooths out the downside of volatility.

“The value of product will go up and down but there is the comfort of capital protection.”

Jones-Pritchard said investors still need to look at the underlying economics, but the downturn in markets has opened up plenty of opportunities.

However, structured products do come at a cost due to the financing component.

“The cost of the product, the financing, should be looked at before an investor makes a choice,” he said.

“The cost of financing has gone up and it has become more expensive because of the cost of borrowing.

“But JP Morgan has managed to arrange financing interest at 8.5 per cent.”

The fund manager is confident structured products are a growth segment and is launching three new investments.

“We are creating products that will deliver returns over a medium-term,” Jones-Pritchard said.

“It is also important investors look at the quality of the issuer (of the product) and the financer behind it.

“Who will stand behind the product should it go wrong is very important.”

The type of alternative investment product is also important for matching the right asset class to the investor’s risk profile and objectives.

Select Asset Management portfolio manager, alternatives, Robert Graham-Smith said it was important to look at the diversification the alternative asset will deliver for the investor.

“In a diversified portfolio there should be some alternative assets,” he said.

“We use a number of managers to give a diversified portfolio of alternative investments.”

In the Select Alternatives Portfolio, hedge funds account for 42 per cent of the investment strategy, managed futures 18 per cent, private equity 9 per cent, commodities 6 per cent, gold and infrastructure 9 per cent respectively, and other alternative investments 2 per cent.

“We do not invest in things we do not want to, such as long credit for example,” Graham-Smith said.

The use of hedge funds in the product should not be of a concern to investors, he said.

“I think it is important for people to understand that the managers that got into difficulties last year were not hedge funds.

“However, the lack of liquidity and the credit crunch has affected some areas of alternative investments.”

Graham-Smith said Select prefers to use market neutral hedge funds and a variety of investments in the fund to deliver performance.

At the end of the March quarter, the fund delivered a 0.03 per cent return for this year compared to 9.63 per cent for 2007.

“It is a tough environment, but our performance was up,” he said.

“Although the fund is well down on previous years, it is about preserving capital.”

Graham-Smith said there were still investment opportunities for the fund and some of the underlying managers had performed well, benefiting from market volatility.

“They are investing in a liquid market, but you still have to be careful picking managers,” he said.

“The key for us is diversification and not betting the farm on any one manager.

“That is why we have a range of investments in our fund.”

Graham-Smith said alternative investments were out of favour for the wrong reasons.

“I think it is important to differentiate certain areas of alternatives,” he said.

“If people won’t consider hedge funds, there are other areas such as commodities.”

Investment portfolios

Adviser group Perpetual Private Clients believes there is a strong argument for using alternative investments, and it now has the results to confirm its belief.

Perpetual Private Clients head Scott Riedel said the group looked at alternative investments about 18 months ago for their philanthropic portfolios.

“We looked at US investments and concluded alternative investments do have a place in a philanthropic fund,” he said.

“The aim was to increase the return of the portfolio and enhance income.”

Perpetual researched the sector through its own asset management team and external consultants.

“We are now applying alternative strategies to our clients’ portfolios; and it is not just high growth portfolios,” Riedel said.

“Alternative investments should be part of all investment portfolios.”

Perpetual has defined alternative investments as those that fall outside the classic asset classes or use sophisticated strategies.

“There are growth alternatives, and these are about providing long-term capital growth, as well as private equity and infrastructure,” he said.

“We are looking for long-term capital growth and finding that by including alternative investments in a clients’ portfolio — about a 15 per cent allocation — it is increasing returns by 1 to 2 per cent and decreasing volatility by 4 per cent.”

Riedel said it was a major shift in lifting returns and bringing down volatility.

The allocation of 15 per cent to alternative investments instead of the more traditional 10 per cent was defended by Riedel.

“Institutions have been giving between 14 to 20 per cent to alternative assets,” he said.

“In the US and Europe the proportions are larger, and it will evolve over time here as people [become more] comfortable about the asset class.”

Riedel said some investors were concerned about the liquidity issues of some assets in alternative investments, but he felt people would eventually become comfortable with this.

“There needs to be a lot of education involving how these types of investments work,” he said.

“Similarly, people need to understand these are not short-term investments or about investing at a particular time.”

Perpetual introduces alternative investments slowly into a client’s portfolio to enable them to understand how the asset class works.

“We do staged entry into alternatives over a three to six-month period,” Riedel said.

“We believe the slow way of investing is a good way to introduce alternatives into a portfolio.”

He admits some investors are concerned about fees in the products, but he believes the level of expertise needed to run an alternative assets portfolio justifies the fees.

“These products are specialist by nature and the investor is accessing a high level of expertise, so education is needed on the various fees,” Riedel said.