Pushing investments over the hedge

For financial planners to attract and retain affluent clients, the so-called emerging wealth investor, such as self managed super fund trustees, they need to offer a broader range of products according to a recent US survey.

For financial planners to attract and retain affluent clients, the so-called emerging wealth investor, such as self managed super fund trustees, they need to offer a broader range of products according to a recent US survey.

According to Andrew Crawford, Managing Director of InvestorSource, “Australia appears to be in the middle of a period of monetary tightening, savvy DIY super fund trustees are increasingly looking at new types of funds to provide them with consistent returns over the longer term”.

After undertaking a review of the alternative investments market locally he believes there are a number of funds available which offer DIY super funds with access to some more rewarding alternative investment opportunities in unlisted companies or through the use of non-traditional investment techniques.

Hedge funds are one of the most talked-about financial product innovations of recent times. They have a mystique; an aura that is attractive to investors of all types. Their remoteness and exclusivity makes them even more desirable, especially to the investor of emerging wealth.

In order to look at the next market evolution of hedge funds, US-based Private Asset Management conducted the 1999 Perceptions of Hedge Funds Study. They went to 267 respondents in the US with incomes of $100,000 or more who said they are familiar with but not currently invested in hedge funds.

According to Russ Prince of Private Asset Management, “US investors with emerging wealth want a piece of the hedge fund pie”. Prince believes they gloss over the risk associated with hedge fund investments and sidestep regulatory issues. They want to be in the market for hedge funds, but their naivete could represent new challenges to providers.

Table 1 — Emerging Wealth Investor in the US want Hedge Fund Opportunities

Question Respondents

Hedge funds will increasingly be available to less wealthy investors 69%

Hedge funds are unfair — only the rich get to invest 68%

The most talented investment managers run hedge funds 65%

Everyone should have the opportunity to invest in hedge funds 64%

I would invest in a hedge fund if I had the opportunity 62%

Hedge funds are a good way to create a diversified portfolio 57%

Source: Private Asset Management

On the one hand, there are not a lot of risk factors associated with hedge funds in the minds of these investors. Sure, they understand that there might be more hedge funds on the brink of collapse, like Long Term Capital Management. In fact, 43.4 per cent say they are concerned about this possibility.

Will hedge funds cause the next world depression? Not very likely, say these investors. Just 16 per cent think so. These investors also do not think that hedge fund investing played any role in the Asian crisis. Unlike Malaysia’s Prime Minister Mahatir.

Prince believes there is the perception that hedge funds still account for such a small share of overall investing that they don't exert a significant effect either positively or negatively. That is why these investors can imagine that there might be more problems like those of Long Term Capital Management on the one hand, but no effect on markets. Thus, hedge funds cannot claim credit for the U.S. bull market, but also can escape blame for the problem in Asian markets, according to these investors.

According to the survey results emerging wealth investors hold confusing and contrary ideas about regulation and hedge funds. Although nearly two-thirds (63 per cent) feel that hedge funds will become increasingly more regulated, almost as many (54 per cent) feel that more regulation will be counter-productive as hedge funds will simply move offshore. Some (40 per cent) feel hedge funds will be forced to disclose more information about themselves.

Not many think hedge funds are threatening or risky because they are deregulated. Just 30 per cent agree with that opinion, and only one in five say hedge funds should be as highly regulated as any other investment.

Investors with emerging wealth tend to be younger than investors with established wealth. As a result, many have never experienced a long bear market or deep economic recession. This group has less understanding of the relationship between regulation and risk.

Emerging wealth investors are eager to be able to invest in hedge funds. They think the current hedge fund set up is unfair; they believe only the wealthy get the chance to invest in hedge funds (68 per cent).

They are also envious. They believe that the most talented investment managers are siphoned off to run hedge funds (65 per cent) and thus are not available to them. To make the situation fairer, they think everyone should have the opportunity to invest in hedge funds (64 per cent).

Not only that, they will put their money where their opinions are. Most (62 per cent) say they would invest in hedge funds if they had the opportunity. There is also the general perception that hedge funds are a good way to create a diversified portfolio (57 per cent).

Prince believes emerging wealth investors want to share in the rewards of excellent investment management and state-of-the-art investment approaches in their diversified portfolios. They expect to be able to invest in hedge funds in the near future.

Alternative investments, such as those offered by AMP, Deutsche and Macquarie provide investors with an added level of asset class diversification. In addition, by including the alternative investment asset class in a portfolio you can earn a higher level of return for each unit of risk taken compared to traditional share investments. For example, the Macquarie fund generated an annual return of 23.1 per cent between 1982 to 1997 which is 6.6 per cent higher than the return of the All Ordinaries Accumulation Index after fees.

Table 2 — Risk/Return Comparison of Alternative Investment funds to share index benchmark

As at December 31, 1999 1 Year

Return 3 Year Avg. Return Volatility

(3yr Std Dev)

Positive Monthly Returns

( per cent total) Worst Monthly Loss

(1/95-1/00) Risk/ Reward Ratio

Australian Equity (All Ord’s Index) 16.1 per cent 13.3 per cent 12.4% 70% -10.6% 0.9

AMP Direct Investment Unit 11.9% 13.8% 4.4% 92% -0.4% 3.2

Deutsche Strategic Value Fund 20.1% 17.1% 4.0% 93% -2.0% 4.3

Source: InvestorSource

When investors want a product, they will get it. Therefore, financial planners who want to work with these investors are going to need to be able to offer hedge fund products. Over the last year a number of hedge /alternative investment funds have been made available (or are planned to launch soon such as Coastal Capital) to the emerging wealthy investor and smaller retail investors in a number of forms. Included here are funds of funds as well as through limited liability companies.

The funds explained

Three factors that are common to these funds is their focus on either generating stable, consistent return patterns (especially AMP) or the implementation of deliberate investment strategies to minimise risk, volatility over the long term (especially Hedge Funds of Australia), or the investment in start-up/venture capital (Macquarie and Deutsche).

Fund Type of Fund Objective Description Portfolio stage of development

Portfolio Holdings

AMP Direct Investment Unit Unlisted Companies Pooled Super Trust To outperform the All Ordinaries Accumulation index over the long term This fund has been in operation for over ten years and has consistently outperformed the All Ordinaries Index each year by investing in a diversified portfolio of unlisted resource, industrial and infrastructure assets. Unlike the other funds, the AMP fund invests at least 50% of the fund in stable cash flow generative assets, such as infrastructure assets. Start-up 26%

Expansion 11%

Mature 63% Tomago Aluminium Smelter JV

World Net Communications

Infrastructure Equity Fund

Equatorial Mining

Gove Aluminium

Berri Limited

Olex Holdings

Pinnacl