Fixed Income  

The no-nonsense guide to alternative investments

This article is part of
Hunt for Income - March 2015

Alternatives is a catch-all term that is open to interpretation.

Recently, this term has applied to non-traditional investments in asset classes in which investors are wary of taking exposure or cautious in their positioning.

This is evident in opportunities flagged as ‘equity alternative’, ‘bond alternative’ or ‘property alternative’ investments. Essentially, these opportunities are not seeking to provide the same sensitivity (or beta) of being a long-only investor in the traditional asset class.

Alternatives can also relate to investments where the fundamental drivers to performance remain largely insensitive to movements in traditional asset classes. Consequently, these ‘genuine alternatives’ can be used to diversify a portfolio as they provide low correlation to wider markets.

When investing in any type of alternative asset, consideration must be given to its underlying liquidity as well as the investment structure by which it is accessed.

On the whole, underlying liquidity is limited by the specialist nature and confined participation of the investment opportunity. In these cases, committed closed-end vehicles are generally the optimum way to access these opportunities.

So, what are these obscure investments, and how can they be used? Convertibles best illustrate equity alternatives.

In spite of the essence of this asset being rooted in a corporate bond, convertibles provide investors with equity participation through a future conversion option. In this way, there is the asymmetric attraction of equity upside with bond floors for protection.

Convertible valuations became increasingly attractive in 2014, largely as a result of an increase of new issuances, many of which have been issued with higher yields at lower premiums.

Bond alternatives seek to provide attractive credit returns against the backdrop of lending retrenchment seen in the banking sectors since 2008.

For example, an abnormally high return from senior loans secured against property assets can be achieved in property debt funds.

Investing more directly in commercial property assets can lead to a more specialist approach offering less sensitivity to the property cycle.

With the structural change in the retail sector away from the high street towards click and collect, mobile and e-commerce, there is currently an acute shortage of big-box logistics units in the UK.

Tenants are having to commit to long-term leases due to the supply/demand imbalance caused by indexed rent reviews due to the high barrier to entry for site acquisition and development.

This is resulting in a robust 6 per cent yield.

Genuine alternatives are, by nature, more esoteric investments.

They require a proactive research approach to gain sufficient understanding of the risk and reward opportunity.

The inherent advantage of putting in this effort is to benefit from the idiosyncratic risks of the specialism in providing real diversification, whilst exploiting any compelling risk-adjusted returns that may be presented.

Ian Rees is head of research, multi-asset funds at Premier Asset Management