Across The Border

Asia investors being pointed towards alternative investments to hedge current ‘unpredictables’ such as Trump and Brexit

Alternatives include hedge funds, private equity, managed futures, real-estate and commodities like gold

PUBLISHED : Wednesday, 16 November, 2016, 3:44pm
UPDATED : Wednesday, 16 November, 2016, 10:03pm

Asian investors should look more to alternative investments to balance their portfolios and reduce risk as the global markets remain volatile and politics unpredictable.

In the wake of the unexpected Trump win in the US presidential election last week, people are waiting to see whether the Fed will in fact now raise interest rates in December, as had been widely expected before the result.

Now coming hot on the heels of Trump’s triumph are a referendum on constitutional reform in Italy on December 4, and the French presidential election next year.

It’s also far from clear whether the market can expect a co-called “soft” or “hard” Brexit, or what the US will look like under the new president-elect, who’s not only untested in such a role, but is still keeping the world waiting on whether his planned, and sometimes outrageous, pre-election pledges turn out to be nothing but bombastic rhetoric.

“These are all the known unknowns, and there may be other unknown unknowns...You don’t know what’s going to happen in the short term,” Matthew Riley, head of research at Natixis Portfolio Research and Consulting Group.

Riley says it’s impossible to always forecast the market correctly, but thinks Asian investors need to allocate more resources into alternatives to achieve long-term returns.

An alternative investment is an asset that’s not one of the traditional investment types, such as stocks, bonds and cash.

Most alternative investment assets are held by institutional investors or accredited high-net-worth individuals because of their complex nature and limited regulations.

Alternative investments include hedge funds, private equity, managed futures, real-estate and commodities like gold, and don’t move in same direction as equities or fixed income.

But they can help to balance investor’ returns amid market volatility.

On November 9, the day after US election day, the Hang Seng Index dropped 2.16 per cent or 494.3 points, but the price of gold soared 5.4 per cent to break the US$1,300 threshold per ounce.

In Singapore there is virtually zero interest in alternatives, while in the UK , the portion of alternatives in the retail and wholesale mix is 18 per cent, and in France it jumps to 28 per cent, according to Natixis’ data based on one-year average data and moderate risk portfolios.

“Asian investors have tended to be underweight in alternative investments relative to their US and European counterparts... But we are seeing initial forays now being made, typically ranging from 3 per cent to 10 per cent or more in some cases,” John McCareins, Hong Kong-based APAC managing director at Northern Trust Asset Management.

Stringent regulation and investor misconception, especially of hedge funds, have historically dampened growth of alternatives in Asian markets, including Hong Kong.

“It’s not easy to get alternatives registered at by the Securities and Futures Commission [in Hong Kong], and they are regulated strictly to restrict retail investor access to them,” Riley said.

In other markets like Europe and the US, there’s a framework in place, the Undertakings for the Collective Investment in Transferable Securities (UCITS) that creates a harmonised regime throughout the continent for the management and sale of mutual funds.

The agreement insures investors more protection and transparency, compared with hedge funds or private equity funds, which lack transparency and liquidity.

“UCITS could work in Hong Kong as it allows investors to gain access to alternatives with safety,” Riley said. “The growth of UCITS funds has led to an increase in alternative funds in Europe and we expect something similar could happen in Hong Kong.”

Hedge funds are supposed to offer a hedge against investment risk, but have been widely perceived as dangerous by Asian investors, after the US hedge fund boom ended so badly during 2008 financial crisis. The ponzi scheme run by former Nasdaq chairman Bernie Madoff’s hedge fund until 2009 seriously tarnished the image for the industry.

“There are also misconceptions that alternative funds either generate huge returns like that of George Soros, or blow up like Long-term Capital Management (LTCM) [the huge hedge fund led by Nobel Prize-winning economists and renowned Wall Street traders, that nearly collapsed the global financial system in 1998 as a result of its high-risk arbitrage trading strategies].

“But actually most liquid alternatives have similar low risk to fixed income. The asset management industry hasn’t done a good job in educating people,” Riley said.

The adoption of alternatives tends to be in response to longer-term outlooks for muted equity returns and a “lower for longer” interest rate environment, Northern Trust’s McCareins said.

“We have worked with institutional investors who have used hedge funds as a substitute ‘risk control asset’ for fixed income. The goal was not outlandish returns but rather a lower risk profile with less imbedded interest rate risk relative to their fixed income investments, and over recent periods results have been in-line with expectations,” McCareins said.

Investor education, including setting proper expected returns on investment, is critical, he said.

Riley added that active managers, such as alternative funds managers, still have a role to play as long as investors want to beat the benchmarks, even though the portion of passively managed assets in the US equity market has grown from 11 to 30 per cent in last 20 years.

As the rise of passive investment increases and the competition grows among remaining active managers, he says, they will be forced to lower their fees and differentiate their asset allocation from benchmarks, which would be healthy for the industry.