Multi-assetFeb 25 2013

Generating income from alternative assets

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Equities have started 2013 strongly as macroeconomic issues appear to have temporarily reached a plateau in both Europe and the US

However, many think the sharp rally, which has seen the FTSE 100 soar past the 6,000 mark to reach a five year high of 6,347.24 on January 28 2013, is set for a correction.

If this is the case and equities suddenly fall back, with historically low interest rates keeping guilt yields low and corporate bonds in what some would call a ‘bubble’, where should investors look next for returns.

Multi-asset funds seem the logical choice – the very title suggests a range of investments - but where are managers finding good investment opportunities outside of the traditional bonds and equity sectors, and at what risk?

Broadening horizons

Justin Onuekwusi, multi-asset fund manager at Aviva Investors, explains that 10-15 years ago traditional multi-asset fund invested in three main asset classes: active equities, active fixed income and cash, with a few investing in property.

“Since then you’ve seen the average retail fund invest away from those asset classes really for two reasons, one is for diversification as asset classes outside those traditional ones can help smooth out the journey of investors over the investment cycle.

“Also there has been a demand for multi-asset fund managers to be more active in their asset allocation, so the more tools you have in the box the more levers you have to pull and the more active you can be in your allocation.

“But also these alternative assets have become more investable.”

Asset classes now being utilised by multi-asset managers range from property, commodities, infrastructure, absolute return funds, structured products and alternative fixed income instruments such as mortgage backed securities (MBS), collateralised loan obligations (CLOs) and floating rate bonds.

The options are wide-ranging depending on the investment remit of the fund and the investment approach of the manager.

Mona Shah, assistant fund manager on Rathbone multi-asset portfolios, adds: “Investors must look at ‘alternative’ strategies in tandem with the rest of their investment objectives. It is imperative to buy a product that fits within the context of the overall portfolio.”

Rob Burdett, co-head of multi-manager at F&C Investments, says the team tends to only invest in assets outside of the ordinary “when we really believe they are going to provide a decent return”.

He adds: “There is sometimes a danger people invest in other assets just because of correlation and things like that, and they can very much change, as we saw in 2008.”

Currently the manager is looking at income producing areas in light of historically low interest rates and higher inflation.

“We are looking for things that will continue to provide a decent yield if interest rates changed, without the capital loss you would have in a gilt or investment grade corporate bond if interest rates go up. If we can find some inflation protection then that’s good too,” explains Mr Burdett.

Reviewing the risks

Mr Onuekwusi agrees that since 2008 the environment has been one where risk assets have been trading in lock-step with each other, and some of the alternative asset classes have started behaving more like risk assets.

“The difficulty of a multi- asset fund manager is to really try and find an asset class that combines that true diversification you want over the investment cycle.”

Within his portfolios he uses property and commodities in addition to absolute return bond funds, which allow him to be more active in the fixed income space and benefit from both rising and falling yield environments.

He admits, however, that absolute return funds in general have struggled to perform with some disappointing results, but points out they are a large and growing segment of the alternatives sector.

He says: “For alternatives, especially the absolute return route, it is important you do extra due diligence because some of them are quite complex to understand and it is important to dig deep and really fully understand what you’re investing in.”

Ms Shah agrees that investors must understand the performance drivers of a product and how these might change over time, as in the case of managed futures.

She explains: “These strategies are computer-driven, and profit by identifying medium-term trends. They can take long and short positions across equities, commodities, interest rates, government bonds and currencies.

“While they can exhibit 15-20 per cent volatility, these strategies tend to be lowly-correlated with risk assets over the cycle. They also tend to perform well when volatility rises. The nature of these strategies means that returns are often lumpy, so there is no ‘right time’ to invest, although buying on dips can be beneficial.”

Property and infrastructure

Although more sophisticated strategies are available to investors, one of the more popular alternative assets in a portfolio is property and following on from that, infrastructure.

Ben Seager-Scott, senior research analyst at Bestinvest, says: “There is little sense in making an investment purely for diversification reasons in the absence of solid investment thesis.

“A popular alternative is property, which usually means commercial property, and can be accessed either by investing in a portfolio of physical buildings, or through listed property securities.

“Returns from property tend to be less volatile than bonds and equities, while tenancy agreements tend to have upward-only rental agreements, which help ensure rental income can at least keep pace with inflation.”

Mr Burdett holds a couple of infrastructure funds as a “solid, steady backbone to the portfolio”, but is not that keen on property suggesting investors need to be “very picky”.

However, he is trying to find some property proxies, examples of which are Medix, a listed company that invests in NHS doctor surgeries, and a caravan park fund called Darwin Leisure Property.

“Whereas real estate was the eye of the storm, the core of the credit crunch, caravan parks are a beneficiary of the recession. We’re all ‘staycationers’ as the pound is relatively weak and we have less money to spend. Caravan parks have been seeing consistent rises in bookings.”

Commodity investing is also a popular choice, particularly precious metals, oil, gas and agriculture, although they can be highly volatile.

Mr Seager-Scott says: “The long-term attraction of commodities comes down to the fact that these are all limited resources, and the expectation is that demand is set to increase, driven primarily from the developing economies.”

The wide choice of alternatives means opportunities for investors are increasing making the life of a multi-asset fund more challenging.

But as Mr Onuekwusi points out: “Nowadays we wouldn’t build a multi-asset fund without an alternatives allocation. A multi-asset fund without alternatives actually isn’t truly a multi-asset fund.”