ALTERNATIVE INVESTMENTS – SHOULD THEY ALL BE TARRED WITH THE SAME BRUSH?

Hands up who has not read of one Alternatives fund or another closing down and leaving investors trapped with, at best, a long wait for their money, at worst, losing some or all of it?

Looking around this “virtual room”, I find it hard to imagine anyone with their arm raised – quite simply because this has not been a rare occurrence in recent times.  What seemed like ‘a good idea at the time,’ can turn into an episode of The Twilight Zone – except that this is real.

Life savings, pension pots and other sums of hard-earned money can get snagged in a fund structure that has closed its doors to redemptions, often with dire consequences for investors who have entrusted lifestyle-critical sums to these vehicles.

Forestry, debt financing, student accommodation and commercial mortgages are intrinsically attractive and popular asset classes for the right investors – and within the right structure. However, get the alignment between investor and structure wrong and bad things are likely to happen.

Therefore, should all Alternatives be tarred with the same brush?  Will they all blow-up and sentence their shareholders to a lifetime of separation from their capital?  The resounding answer is of course not.  That is blatant nonsense, but you can easily see why some may feel that way.

Sadly, some investors who could really use the diversity and potential returns that good Alternatives can provide are deterred by horror stories which involve in some cases fraud, deception, greed and simply poor management.  The vision of a wicked fund manager living it up on your life savings is one to chill most peoples’ bones.

Fortunately, the overwhelming majority of Alternative investments are stories with happy endings, where dedicated management teams combine with appropriate investors and share a truly positive investing experience.

How to ensure this becomes reality for you or your clients?  This piece is not about investment planning nor financial advice, and crafting positive outcomes is beyond the scope of this article.  It is more the preserve of the band of professionals who do a great job of creating portfolios for their clients.

What we are discussing here is ensuring that investors who are suitably well-informed and with sufficient financial muscle to separate shorter-term capital from the longer-term, will feel comfortable that not all Alternatives should be tarred with the same brush.  There are significant differences in the way funds and other vehicles are structured, regulated and governed.  Strategies vary enormously even within the same or similar asset classes.  What is good for one could be bad for another.

Alternatives for the retail investor?

Regulators, such as the UK’s FCA, have made Alternative investing a virtual impossibility for the “retail” investor – some would say that is a good thing.  The key is though, that what is really needed is a better understanding of what the asset is designed to do, what its limitations are and whether any one investor is appropriate to invest.

A simple headroom test (say investible capital of EUR500,000) may not be enough to ensure the investor understands the risks and potential drawbacks of the investment they are thinking of making.  Having the means to invest is not necessarily the same as having the “savvy” to invest.

Generally speaking, it’s not just the amount available to put in to an investment, it’s the spread that the portfolio has that counts.  Even a smaller investor with quite a modest portfolio could invest quite well, provided their spread of investments was sufficiently wide enough to avoid over-concentration on assets and vehicles that may be difficult or slow to liquidate, or those which require an extended term to produce a decent and efficient return.

In the real world, though, each holding would be quite small in size and possibly not economical for the fund manager to handle – particularly where KYC may be onerous.

For these reasons, Alternatives will gravitate towards the demographic that is the best fit and that has the closest investor/manager alignment – this may be be the Family Office, HNWI, Private Bank client whose investment capabilities include:

  • Sufficient resources for effective diversification
  • A mix of investment horizons – short, medium and long – and assets best fitting those timescales
  • A mix of risk attitudes that are aligned with the assets held
  • An investment management capability that ensures regular monitoring and reviews of the underlying assets and returns

What makes a good Alternatives choice?

That’s a question that can only be answered on an individual basis using expertise and KYC beyond the scope of this article, but as a few pointers:

  • Get to know the Managers
  • What makes them tick?
  • Why (not just how) do they manage money?
  • Understand how they handle mistakes as well as successes
  • How long do you wait until you see returns?
  • How long should you invest?
  • What’s the Regulatory regime?
  • Is it over-robust? (Too much can be a drawback)
  • Does the strategy make sense?
  • Ensure you (or someone you trust) understands the strategy and its pros and cons

There is no fool-proof investment formula – you win some, you lose some.  However, don’t let fund failures put you off investing in the newly-emerging Alternatives that we see every day.

Having a good Alternatives portfolio could be good for your wealth and, in my view, in their assessment of potential Alternatives, investors should assess new opportunities with an open mind, and leave the tar brush firmly in its pot.

Check out some of our other articles here.