Why Alternative Assets Are Key

Opening The Door
Part 1
By Justin Perun & Scott Foster
Why Alternative
Assets Are Key
Time is now for individual investors
to follow the lead of institutions
F
ollowing the 2008 financial crisis, the global financial markets have
experienced an increase in volatility, growing uncertainty surrounding
the Euro and other international currencies, coupled with a significant
rise in government intervention via the Dodd-Frank Financial Reform
Act which informed investors of their vulnerability in the
market and established a new investor class. The
OPENING
THE
DOOR
mandate of these sophisticated investors’ is clear; they
Over the next several weeks,
Kingdom Trust will be
are looking for increased transparency, liquidity and
publishing a series of white
focusing on alternative
risk management resulting in a rise in alternative investment papers
assets and the value that they
offer the investor,
asset flows.
as well as the advisor.
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PART ONE
Along with these individual investors, financial brokers and advisors have expressed a strong opinion that there is a need for a different approach to money management; focusing on a new paradigm of portfolio construction, risk management,
transparency and liquidity. Financial advisors are re-evaluating the effectiveness of the
traditional 60/40 allocation model. The argument that equities outperform other assets
classes in the long term often fails to mention the risk undertaken to achieve such performance. Thus, recent investor mandates are requiring financial advisors to re-frame
portfolio construction by addressing nimbleness in the markets, true portfolio diversification, liquidity and the ability to capture non-correlated enhanced return (alpha) while
addressing investor cash flows needs/demands in an inefficient equity market. As a
result, the focus has now turned to the use of alternative investments as a source of
portfolio diversification.
By incorporating alternatives investments into a traditional 60/40 allocation model, it
enhances the overall return (alpha) while dampening an investors’ exposure to systematic or market risk. Systematic or market risk can be defined as risk inherent in the
financial markets. “Systematic or market risk involves factors that affect the economy at
large, and includes rising inflation, interest rate changes, currency fluctuations, natural
disasters and social or political turmoil”1 In recent years, investors of alternatives have
favored investments in real estate and commodities such as precious metals.
Alternative investments enable investors to allocate and diversify their exposure beyond traditional stock, bond and cash equivalents. The most predominant
alternative investments are classified as hedge funds, private equity, managed
futures or real estate investments.
Hedge funds are actively managed investment products seeking to achieve an absolute
return. This investment product is regulated by the country it is domiciled in, in the US
only accredited investor or qualified purchaser can participate via a limited partnership
interest or managed account. Hedge fund strategies include but are not limited to: long/
short equity, global macro and event driven.
A recent industry survey conducted by Deutsche Bank quantifies the maturation of the
alternative investment industry with a focus on hedge fund investments. Respondents to
the survey include institutions (pension, endowment, foundations), fund of hedge funds,
private banks, consultants and family offices. Noteworthy highlights of the survey include but are not limited to: 2
Why Alternative Assets Are Key
60/40
Model
Financial advisors are
re-evaluating the effectiveness
of the traditional 60/40 allocation
model. The argument that
equities outperform other assets
classes in the long term often fails
to mention the risk undertaken
to achieve such performance.
Thus, recent investor mandates
are requiring financial advisors
to re-frame portfolio construction
by addressing nimbleness in the
markets, true portfolio diversification, liquidity and the ability to
capture non-correlated enhanced
return (alpha) while addressing investor cash flows needs/
demands in an inefficient equity
market. As a result, the focus has
now turned to the use of alternative investments as a source of
portfolio diversification.
By incorporating alternatives
investments into a traditional
60/40 allocation model, it
enhances the overall return
(alpha) while dampening an
investors’ exposure to systematic
or market risk
1 “Asset Allocation Can Reduce Systematic Risk.” The most pervasive risk facing investors – systematic risk – can be reduced through asset allocation.
Authored - Adrianna Reyneri on February 5, 2013.
2 Deutsche Bank Survey-Deutsche Bank Alternative Investment Survey identifies investor expectations for 2013.
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PART ONE
• Investors expect continued growth, predicting industry assets under management
(AUM) will reach an all time high of $2.5 trillion by year end, forecasting net
inflows of $123 billion in 2013.
• Hedge funds are no longer a stand-alone asset class. Institutional investors have
moved from a traditional asset class allocation to a risk-based approach.
•
Investors now expect steady, predictable return streams. Two thirds of investors
feel that hedge funds have performed as expected or better in 2012. For 2013, 65%
of investors and 79% of institutional investors are targeting returns of 5-10% from
hedge funds.
•
Institutional investors dominate hedge fund AUM. Whilst 57% of private banks
decreased hedge fund AUM, almost 70% of pension funds increased their
allocations. Almost half of pension funds expect to increase allocations by
$100 million or more in 2013.
Private equity is an investment into a company that is not publicly traded on any market exchange. The intent of the investment is typically to provide operating capital to
a selected company to support growth, new product development or organizational
restructuring. These investments can be accessed through a private equity or venture
capital firm or directly by what is commonly referred to as an angel investor.
Managed futures are an actively managed investment product seeking to achieve an
absolute return in the futures market. This investment product is regulated in the US by
either the Commodity Futures Trading Commission (CFTC) and/or the National Futures
Association (NFA). An individual investor can access a managed futures account either
through a commodity pool operator (CPO) or commodity trading advisor (CTA). Managed
futures strategies include but are limited to: futures on equities, futures on options and
futures on commodities (ex: beans, cattle, precious metals). These strategies tend to be
un-correlated to the equity market, thus implying a reduction of volatility and risk within
an individual’s overall investment portfolio.
Why Alternative Assets Are Key
Alternative
Assets
True diversity to a more informed
investor also includes alternative
assets that are unrelated to the
stock market.
Here is a partial sampling of
alternative assets:
Real estate
Promissory note
Private business
Precious metals
Tax liens
Mortgages
Real estate is an investment into a property in either the land and/or the commercial/
residential buildings on it. The intent of the investment can vary from purely a longterm investment perspective by leveraging the inherent value of the property to shorterterm monthly cash flow generating investment. Real estate can be accessed directly or
through various types of fund structures and historically has been the most un-correlated
asset to the stock market.
Rental properties
Farm land
Cattle
Timberland
Commercial property
Race horses
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PART ONE
Over the last ten (10) years, overall asset allocation to alternative investments has
significantly evolved. Starting at the rise of alternative investments in 2003, high net
worth (accredited investor), ultra high net worth (qualified purchaser) and family offices
comprised 75 percent of the investable assets in alternative investments. Institutional
investors (ie: pension, endowment, foundation) at that time represented 25 percent of
the investable assets and since then have grown to over 60 percent as of 2011. It is
only over the last year that high net worth and retail investors have closed the gap, now
representing an estimated 45 percent of investable assets in alternatives. According to
the Center for Retirement Research at Boston College, the rise in retail investors in alternatives is partially contributed to the rise in defined-contribution plans. “The number
of US workers with only so-called defined-benefit retirement plans has fallen by about a
third over the last two decades while those paying only into defined-contribution plans,
such as 401(k) savings accounts, has risen more than five fold (5X), to about 68 percent
of workers in 2010.” 3
Over the last year, investment management firms have responded by broadening their
product offerings to accommodate increased demand by lowering investment minimums, increasing transparency/liquidity and compressing fee structures. The latest firm
to publicly announce its broadening of product offerings is Washington, DC-based Carlyle Group. It is stated that the firm “hopes to reach a broader swath of wealth—which
the firm estimated at more than $10 trillion,” according to people familiar with Carlyle's
thinking.4
The minimum for entry into Carlyle's funds previously was between $5 million and $20
million, according to a securities filing for the new fund. The new fund, with a minimum
investment of $50,000, will be available to "accredited" investors, essentially those with
$1 million in wealth not including their homes. Private equity firms typically require investors to commit money for 10 years to give the funds time to buy and sell companies.
However, Carlyle’s new fund will let investors withdraw some of their money quarterly
after two years, according to the filing.5
Why Alternative Assets Are Key
‘Alts’
Rising
Starting at the rise of
alternative investments in 2003,
high net worth (accredited
investor), ultra high net worth
(qualified purchaser) and family
offices comprised 75 percent of
the investable assets in alternative
investments. Institutional
investors (ie: pension, endowment, foundation) at that time
represented 25 percent of the
investable assets and since then
have grown to over 60 percent
as of 2011. It is only over the last
year that high net worth and
retail investors have closed the
gap, now representing an
estimated 45 percent of
investable assets in
alternatives.
That being said, institutional investors still represent the most influential investor to
alternative investments while family offices and high net worth and ultra-high net worth
investors continue to increase their exposure to the asset class. Many of these investors
confide in their financial advisor as the best source of information on alternatives. “High
net worth and high income rank their primary advisor as their preferred source of information on alternative investment products, followed by online resources, the financial
news and another financial professional. Self-described aggressive investors are most
likely to consult an online resource, followed by their primary advisor, the financial news
and other financial professionals.” 6
3 Wall Street Journal, March 12, 2013 – “Carlyle Group Lowers Velvet Rope”
4 Wall Street Journal, March 12, 2013 – “Carlyle Group Lowers Velvet Rope”
5 Wall Street Journal, March 12, 2013 – “Carlyle Group Lowers Velvet Rope”
4 “Who Wants Alternative Investment Products?” Which investors have the biggest appetite for alternative investments? Where would they go for
information? Millionaire Corner research provides insight. Authored - Adrianna Reyneri, January 17, 2013.
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PART ONE
Why Alternative Assets Are Key
Financial advisors over the past couple of years have spent a significant amount
of time educating themselves on alternative investments either through professional
networking, online resources and/or industry publications and conferences. A recent
industry survey conducted by Brinker Capital is reported that 48 percent of respondents
(financial advisors) reported to have current exposure to absolute return strategies and
46 percent of these advisors will increase their allocation to the asset class in 2013. Financial advisors not only recognize the positive portfolio impact alternative investments
have on a traditional stock and bond portfolio, but “65 percent of financial advisors view
AR (absolute returns) as a complement to relative return strategies, versus 23 percent
who position it as part of a core/satellite strategy, and 12 percent who use it as a fixed
income substitute.”7
In addition to the inherent portfolio benefits, financial advisors are also leveraging alternative investments, specifically the structure of the investment to assist in retaining current clients and to attract new client mandates. When asked by Brinker Capital in their
most recent survey, fifty-seven percent (57%) of advisors responded they would access
alternative investments through separately managed accounts, while thirty-five percent
(35%) would utilize actively managed ’40 Act mutual funds and only two percent (2%)
would access hedge fund directly on behalf of their clients’.8
In summary, the alternative asset industry is no longer a standalone asset class. Over the
past couple of years alternatives have progressed to a mainstream investment product
that can be accessed by institutional/retail investors as well as industry professionals
such as financial advisors in various structures. These investors remain committed to the
asset class as a way to diversify their overall investment portfolios beyond traditional
stocks, bonds and cash products in a challenging investment environment.
Kingdom Trust is redefining the financial services industry standard in providing institutional custody solutions of assets for investment advisors, family offices and investment
sponsors that seek flexible, innovative and cost effective custody solutions. Our intention is to provide the industry best practices and best execution when it comes to the
custody and administration of alternative investments.
7 “Financial Advisors up allocations to absolute return strategies, says Brinker Barometer” Authored - Emily Perryman, February 27, 2013.
8 “Financial Advisors up allocations to absolute return strategies, says Brinker Barometer” Authored - Emily Perryman, February 27, 2013.
ABOUT THE WRITERS
Justin Perun is the President
of Bull & Bear Capital, LLC, a
boutique alternative investment
consulting firm based in Chicago,
Ill. Scott Foster, who has over 25
years of experience on Wall Street,
is the institutional business
development director for
The Kingdom Trust Company.
Kingdom Trust is registered and
regulated as a non-depository trust
company in the state of South Dakota
headquartered in Sioux Falls, SD. If
you are interested in learning more,
please visit our website at www.
kingdomtrustco.com or by contacting
Scott Foster (Institutional Custody) at
(270) 226-1017.
phone 270.226.1000 toll free 888.753.6972
www.kingdomtrustco.com