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Written by: Ian Barrass and James de Bunsen, Henderson Value Trust plc
12/05/2015
Most investors will be comfortable picking mainstream equity or bond funds – the bedrock of any sensible investment strategy. But what of the non-mainstream areas of the market: specialist and alternative assets?

Although packed with diversification opportunities, many will cautious of selecting funds in these sometimes complex asset classes on account of them being esoteric or inaccessible.

Henderson Value Trust’s objective is selecting funds that allow our clients to invest in specialist assets. Through the many years spent picking alternative funds we’ve seen a multitude of fund managers come through our doors, delivering convincing, impassioned sales pitches. Investment professionals are generally a well-educated and articulate bunch, and therefore adept at spinning a good story. Our job is to judge whether the good story makes a good investment – because mistakes within alternatives can be much harder to rectify or exit.

As such, one lesson stands out when it comes to fund selection: you must be disciplined. Through our experience we’ve distilled our analysis to focus on three key aspects: the quality of the manager, the quality of the assets, and the asset valuation.

  • Manager quality

Fund managers can be assessed in many ways – but it is undoubtedly less straightforward when it comes to alternative and specialist assets. Obvious aspects such as the manager’s track record may not exist in the way you might assess an equity manager, for example, because the strategy or asset class is new or the relevant data is not publicly available. Therefore the analysis has to focus on less on quantitative measures and more on qualitative factors such as their experience, credibility, investment process and commitment to good governance. The operational structure within which the manager works is also key: many specialist strategies are run by boutique firms, not asset management giants with huge resources at their disposal. We need to be confident that our managers have the systems and support they need to deliver on their objectives.

  • Asset quality

Sometimes it is tempting to let the attractive prospective returns on offer from new and interesting funds encourage you to overlook the underlying complexity of the strategy or assets. If we can’t understand with total clarity how the returns will be generated or what the sensitivity of the assets is to various macro factors then we will pass on the opportunity. Illiquidity and leverage (borrowing) are also a common feature of alternative assets and while both can mean there is higher potential return it also means potentially higher risk. Property has both of these features – transactions take time and sometimes high levels of debt are used. We try to ensure the right balance is struck so that our property investments can withstand meaningful asset price falls and still cover interest payments from rental income.

  • Valuation

Non-mainstream asset classes tend, as mentioned above, to trade less regularly than equities or bonds. Therefore regular price data can be harder to come by. Often independent firms are used to ensure that fair and realistic valuations are reflected in a portfolio. However, the valuation methodology often uses subjective metrics, such as forecasts of future long-term interest rates or inflation. We need to be confident that an asset priced off anything other than robust market data is valued in a conservative manner that is as objective as possible. We then try to gauge whether the asset has any value where we are in the cycle for that particular asset i.e. how much more upside is there and how much does that compare to potential downside. At the moment, for example, although we like the stable, cash generative return profile of social infrastructure investments, the trusts in this space look overvalued to us, trading as they do at double-digit premiums.

There is no substitute for discipline and restraint in specialised areas of the market; this, we believe, makes the best of the unusual opportunities we seek for our investors.

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