BLOG: The time to consider alternatives

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John Husselbee, Head of Multi-Asset at Liontrust, talks about the advantages and disadvantages of using alternative investments.
BLOG: The time to consider alternatives

Alternative investments can be broadly defined as either a non-traditional asset class such as Commodities or a fund using a non-traditional investment strategy such as shorting. They are designed to be less sensitive to moves in interest rate expectations and stock market valuations, looking to provide investors with effective diversification.

When everything is on the up, investors don’t care too much for diversification. It is only on the way down they reach out for such diversifiers. This year to date has been a good example, because despite the large amount of geopolitical turmoil, including in Ukraine, Thailand and more recently Iraq and Gaza, markets continued to climb and volatility remained near historic lows. This complacency was always vulnerable and we have recently witnessed some unwinding of the risk trade.

The father of the hedge fund industry was Alfred Jones, who launched a fund in 1950s with the ability to both leverage investment and short stocks. For many years, hedge funds were the preserve of the rich and institutions who felt adequately compensated for the structural disadvantages of lack of regulation, transparency and constraints as well as high/complex fees and illiquidity. UK retail demand began in the bear market post the tech boom/bust around the millennium.

For retail investors to access hedge funds, closed ended funds listed on the London Stock Exchange were the initial solution. This structure had already provided access to other illiquid asset classes such as private equity and direct property. A number of fund of hedge funds were launched to invest not only in traditional hedge fund managers but also a growing number of retail fund managers launching offshore hedge funds.

The universe continued to grow throughout the last decade with a number of single manager funds also being launched. These investments generally delivered on their performance expectations although many investors once again were disinterested amidst an equity bull market.

Many retail investors remain sceptical of alternative investments because of the last major bear market beginning in late 2008, remembering how many of these funds failed to provide diversification when required. The issue then was illiquidity, access to hedge funds, private equity, infrastructure and property was provided via closed ended investment trusts.

These investments when tested in a falling market became more correlated to traditional investments than anyone could have thought. Many of these listed hedge funds, both fund of funds and single manager, suffered the same fate, as discounts sharply widened on underlying assets which were typically priced monthly. This resulted in some rich pickings in the aftermath for deep value investors.

Today, with changing regulation and product innovation, retail investors can access open ended vehicles with lower charges, daily liquidity and transparency. There are a growing number of fund offerings from both traditional hedge fund managers and retail asset managers. These potentially provide retail investors with powerful diversification tools to support portfolio construction. However, whilst many of the structural disadvantages of the past may have been addressed, the challenge of finding the right manager for the right time still exists.

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