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The case for alternative investments

Broadening your investment universe.

In North America, institutional investors have an average allocation of 29% to alternative asset classes. In Europe, this sits at 24%. South African institutions, however, allocate less than 2% of their portfolios to alternatives.

“In the global context, we are hugely underweight to alternative asset classes as a whole,” says the head of alternative investments at the Old Mutual Investment Group, Paul Boynton. “And I don’t think that’s the right place to be.”

This is as true for large pension funds as it is for individual investors. South Africans in general have not paid as much attention to the likes of private equity, infrastructure, private debt and hedge funds as investors in most developed markets.

There may be two main reasons for this. The first is a question of accessibility. Historically, it has been difficult to get exposure to these kinds of assets. Individual investors have almost been excluded entirely, unless they are extremely wealthy.

Secondly, there has been less reason for South Africans to look at alternatives because traditional asset classes in this country have performed so well.

“Over 100 years South African equities have given a real return of 7% per year in dollar terms,” says Muitheri Wahome, the chief client officer at Alexander Forbes Investments. “That is remarkable, and so perhaps there has been less incentive to look elsewhere. The reason why more people are talking about alternatives now is because we are expecting lower real returns going into the future.”

The investment case

Wahome adds that the interest in private equity in South Africa is building. Last year allocations increased by 5%.

Boynton argues that there are three reasons why alternative assets make an attractive addition to a portfolio.

“The first is performance,” he says. “If you look at private equity as an asset class in South Africa, Riscura does an industry-wide survey on performance and the ten-year numbers at the moment are running at about 4% or 5% ahead of listed equity.”

In the US, which is the deepest private equity market in the world, the numbers are similar. Private equity delivers returns of between 3% and 5% ahead of listed markets.

“The second major reason for investing in alternatives is diversification,” Boynton adds. “You can diversify your portfolio by being exposed to different sources of return, like infrastructure.”

The risk and payoff profiles of these kinds of investments can look very different to those of traditional asset classes. This makes them attractive, particularly for long-term investors.

“Lastly, and possibly most importantly, is the economic and social impact that can be obtained from investing in these spaces,” says Boynton. “Infrastructure is a case in point. The World Bank estimated that if our energy and transport infrastructure were up to scratch in Africa, we could lift GDP across the continent by 2% per annum.”

There is therefore a meaningful impact that can be made by investing in these kinds of assets. This is not simply altruistic either, as that impact filters into the wider economy, and therefore into broader investment returns.

“CalPERS, which is the largest pension fund in America and a big participant in the US economy, believes that investing in things that accrue positive outcomes for the economy as a whole is a smart thing for them to be doing, even though the direct benefit doesn’t necessarily accrue to them,” says Boynton.

Access

Together with a growing appreciation of the value in alternative investments, changing regulation has also created a more enabling environment. In 2011 Regulation 28 of the Pension Funds Act was re-written to increase the allowable allocation in alternative assets in retirement funding vehicles form 2.5% to 15%.

Government has also made it very appealing to invest in Section 12J venture capital funds through offering attractive tax benefits. Investments into these vehicles are now fully tax deductible and that deduction will be permanent if they are held for five years.

Most recently, hedge funds in South Africa were recognised as collective investment schemes. This has made them essentially as accessible as unit trusts.

At the same time, a number of private equity companies are now listed on the JSE. This gives investors access to unlisted companies through a listed vehicle.

“It is a complex environment, but this shouldn’t make you fearful,” says Wahome. “I think it’s important for investors to think of the opportunities, and get the best ideas into their portfolios.”

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Yes, interesting article…many of us lose sight “the alternatives”. Maybe our over-regulated Retirement fund space leaves less room for alternatives, compared to regulations abroad(?)

A bit off-topic, the main “asset classes” always have been been toted as “Equity, Cash, Gilts/Bonds, Property” (local & offshore)….now….the ideal “managed fund” I would like to see in an asset class mix would be like this:

60% Ethereum (ETH)
25% Bitcoin (BTC)
10% Ripple (XRP)
5% Litecoin (LTC)

As can be seen, nicely balanced, with adequate spread of risk…

What would the fund’s return mandate be you say? It’s anyone’s guess?….perhaps “Inflation plus 600%..?

(almost forgot: such fund needs to be insured against the effect of Electromagnetic Pulse “EMP” weaponry!)

😉

“Peter to John: how did your investment fared the past week? John: “..sadly, I lost it all after the recent, massive Solar Flare / Corona Mass Ejection striking earth…”

Love your answer Michael

I was thinking the exact same thing when reading the article

None of the old farts in financial circles ever refer to crypto !!

To their own demise – lets keep piling up crypto while they comatose

PS you forgot to add Monero to your list

And OMG !

Otherwise, nice !

Good luck with that portfolio, everything in one unproductive “asset” class.

I am writing in response to the article, “The case for alternative investments” (September 27). Hedge funds, as an alternative asset class, were widely mentioned in the article as suitable for our savers and pensioners, but the article fails to consider some of the realities of investing in them.

Hedge funds and their role in financial markets have been under considerable pressure since the global financial crisis. Many pension funds and other institutional investors have questioned the performance of these costly, loosely regulated, typically highly leveraged investment vehicles, especially in light of false promises of absolute returns and a low degree of correlation to other investments. In fact, Calpers, referenced in the article, pulled out entirely from hedge funds in 2014, citing them to be “too complex and costly”.

Scandals such as the infamous Bernie Madoff hedge fund, which turned out to be a Ponzi scheme, do not provide assurance to pension fund trustees who are entrusted with a fiduciary duty to care for assets.

Several studies, including one from the United Kingdom (Imperial College’s own Centre for Hedge Fund Research) uses compelling analysis to show that hedge funds fail to beat the simplicity of a 60% listed equity and 40% bond mix.

Our pension trustees should learn from the mistakes of other “developed” institutions and not follow them into darkness. They should start by ignoring those with a vested interest in selling alternative investments.

The pioneering move by the likes of CalPERS, the Californian pension fund, to allocate a large part of their fund to illiquid, costly alternative investments away from liquid, less costly traditional asset classes, was done at a time when alternative investments offered unique opportunities to a nimble and select group of investors, as opposed to a commoditised offering that hedge funds and private equity investing has become these days.

The envy of the success achieved by the North American institutions has resulted in many other institutions allocating a large part of their funds to alternative investments, the majority of which lost significant value during the global financial crisis (CalPERS lost over $100 billion dollars, almost a quarter of its value).

If South African institutions aims to seek outside guidance, then perhaps the model adopted by the Government Pension Fund of Norway is a more suitable template than CalPERS. The Norway model invests solely in public securities in a diversified manner, stresses cost efficiency, transparency and openness, and has a long-term investment horizon.

What the correspondent omits to mention is that the majority of North American institutions, if not all, are underwater. CalPERS, the largest pension fund in America, referred to in the article, has less than 70% of the money required to pay its pension promises i.e. it is insolvent. No doubt the expensive fees extracted by alternative investment managers have played a role in this decay. My word of caution is to be aware of investment groups bearing “gifts”.

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