Alternative assets: getting first steps right

Alternative assets are in the news as wealth managers look at the need for client exposure to uncorrelated assets.

And it is not just wealth managers who are interested — the ­debate around widening asset diversification was seeded when the Future Fund and industry fund managers began to talk publicly about the positive long-term ­returns generated for their ­clients from both uncorrelated and real assets.

To put that another way — the interest level in these assets has been client-driven.

An uncorrelated asset is one where the price of one asset is not affected by that of another asset — that is, there is no “correlation”.

As an example, the value of water rights does not have any price influence from what the S&P 500 index does overnight — in other words, it is uncorrelated.

One of the defining features of uncorrelated (alternative) assets — and the reason why they don’t follow global equity markets — is that they can generally be illiquid: They are not subject to daily, weekly or, in some instances, monthly pricing, which in turn means they may not be easy to sell quickly.

Another description for them is “real” assets. A real asset is generally physical in its nature. Examples include direct investment infrastructure such as roads, ports and airports, or direct real estate — as opposed to REITs (real estate investment trusts).

The very nature of such assets being illiquid also means they are not for everyone.

I am a strong believer in illiquid assets. However, a rider is our view that this is dependent on an underlying risk profile of a ­client, their appetite for illiquid ­assets and, most importantly, their clear understanding of what they are investing in and why.

Some market players flag their expertise in illiquid assets and aggressively promote investing in them.

However, as with all portfolio construction approaches, diversification and thoughtful use of these assets is advised.

Another important aspect of any long-term approach is to ­ensure investment themes are ­embedded in client portfolios.

These are in areas including water, food/quality of food, and technologies such as artificial intelligence (AI), robotics, genomics and battery storage. Gaining exposure to these themes is not necessarily possible through the listed markets. That means I might consider illiquid assets depending on a client’s goals and profile.

Likewise, in this period of lower interest rates (and against a background of the greatest run in US equity markets in more than a century), gaining exposure to illiquid infrastructure through vehicles such as IPIF, real estate, private equity and diversified credit again may be the correct decision for ­individual clients.

To highlight the importance of this area of investment, a year ago we built out specific asset allocation constraints around these asset classes to ensure their incorporation into portfolios maintained the correct allocations — incorporating risk parameters.

As an overview thought, I ­believe a portfolio approach — as opposed to single asset investment — is the more prudent way to gain exposure. Essentially, it means you are not dependent on the performance of a single asset.

Investors are looking for real as opposed to relative returns in an environment of lower growth — and subdued return expectations for traditional asset classes.

An appropriate allocation to this sector can also lower portfolio volatility and enhance overall risk management.

At the same time as looking closely at alternative/illiquid assets to achieve these goals, I have kept away from multi-strategy funds and “black box” strategies.

This is a continuation of my long-held view that if we cannot explain a strategy clearly and concisely to clients, they should not ­invest in it.

As I mentioned, this is very much a response to clients who understand the upside of illiquid/alternative asset investment — but who also grasp the risk and need for careful use of them using the disciplines of portfolio construction.

That is the vital point about any investment approach, be it for a single stock or for portfolio construction and management involving such vehicles as alter­native/uncorrelated assets.

Will Hamilton is the managing partner of Hamilton Wealth Management, a Melbourne-based wealth manager.

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