Alternative assets are becoming commonplace within a diversified investment portfolio, particularly ...
Alternative assets are becoming commonplace within a diversified investment portfolio, particularly at the higher end of the wealth spectrum. Rather than sticking to the traditional asset classes - equities, bonds and cash - alternatives such as property, structured products, hedge funds, private equity and currencies are featuring more prominently.
There is plenty of evidence as such. According to the 2006 Merrill Lynch Capgemini World Wealth Report, exposure to alternative investments in 2005 was 20%, and is expected to rise to 22% in 2007. This compares to 10% in 2002 and 19% in 2004. Meanwhile, research from the private equity network Hotbed shows that private banks have, on average, doubled their allocation to private equity in client portfolios over the past three years to 10%.
Certainly, this shift is also happening at a big scale. Hermes, the manager of Britain's biggest pension fund, BT, recently revealed plans to switch around £3bn - roughly a third of its UK equity holdings - into hedge funds and private equity, demonstrating how these alternative assets are gaining prominence.
This sudden appetite reflects the recognition of the benefits these assets classes offer. Hedge funds can cushion a portfolio in falling stock markets because of their ability to short stocks or make absolute returns through other sophisticated techniques. Private equity is not correlated to other assets so offers its own set of diversification benefits, as well as the scope for high returns.
Amid the changing landscape of portfolio composition, it is getting increasingly difficult to accurately measure whether the investor's portfolio performance is good, bad or indifferent. This creates a problem. Nowadays, there are very few performance metrics that take into account these new asset classes. Existing indices such as Apcims do not reflect the multi-asset class approach that has become the norm among managers.
This issue is investigated further by Graham Harrison of Asset Risk Consultants (Arc) on page 31 of this issue. Here Harrison argues there are three broad ways in which performance can be measured, including benchmark, peer group and opportunity set, to name but a few.
But each of these has its limitations. Benchmarking (comparing against a particular index) is restricted in that no indices cover all the asset classes available. Comparing against a peer group is easy enough for funds, but how are private client managers of bespoke portfolios meant to know what their rivals are doing and how they are faring?
An analysis of the opportunity set allows the performance to be considered in light of the range of investment decisions that were available to the investment manager under the agreed guidelines. However, this can be like comparing apples with pears, given the different levels of flexibility afforded to different managers.
As Harrison says, several new initiatives have sought to solve this quandry by producing indices reflecting the actual asset allocations employed by private banks. However, these are not based on real outcomes of actual private client portfolios.
Harrison argues that as the private banking industry moves away from static asset allocation benchmarks to a more risk-based approach, the challenge is for a set of indices to be designed for benchmarking performance meeting the desires of both the investment manages and clients. Arc seems fully aware of what needs to be done. Watch this space.
Jenne Mannion, former acting editor
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