New research suggests that high net worth clients are increasing their allocations of alternative assets, but with long investment horizons and continuing uncertainty – what areas are they looking at? Daniel Bone speaks to HSBC and platform provider CAIS about the latest alternative trends.
As the global recession has taken a tight grip on the world’s finances, investors have been reluctant to invest in illiquid funds because of the large risk associated. The alternative investment industry has thus taken a hit, particularly when the lock-up period for invested assets can stretch for up to ten years.
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However, high net worth individuals (HNWIs) are putting money back into hedge funds, real estate and commodities as they seek to protect their assets and acquire high returns.
25% rise in 2012
Total investable assets in the alternative investment market, by those with a net worth of at least $25m, has gone up from 16% in 2007 to 25% in 2012, according to a new survey by Spectrem Group. On the other hand investment in stocks and bonds, including restricted stock and options, has made up only 18% of total investments so far this year.
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By GlobalDataPBI editor Nicholas Moody spoke to Matthew Brown CEO and co-founder of CAIS, a New York-based secure investment platform that allows members to access, research and execute alternative investments. Brown points out that advisers are looking more and more towards versatility in the alternative investment market. This is to give clients a range of attractive options to choose from.
He explains that CAIS now caters for international customers, an indication that global interest in the alternative investments market has shot up in recent years.
"In the US, CAIS services registered investment advisers and wealth management professionals at brokers dealers/wire-houses," he says. "In Europe and Asia, CAIS services private bankers and advisers at both large private banks and boutique IFAs."
Booming alternative market
Brown is in a strong position to see what trends will occur in the market in the next six to 12 months.
"The first trend that we see is that advisers are demanding access to the best products available," Brown explains. "Especially in this market, they don’t want to be limited by maybe a handful of products that certain firms or groups offer – they want a menu of the best, and they want to be able to select what is in the best interests of their client."
Up until the last few years, institutions have led clients to in-house products. However, although advisers are always looking for the best products, Brown says there is a growing trend of consulting independent platforms to look beyond in-house options, leading to a more open architecture.
"Banks are embracing independent platforms in order to give their advisers best selection and best execution while eliminating costs associated with maintaining infrastructure," Brown says, resulting in a move towards the best in class product selection.
Open architecture is key
This move towards open architecture is reflected at HSBC Alternative Investments Limited (HAIL). Faraz Sultan, Global Head of Portfolio Management; and Phelim Bolger, Director, Head of Sales UK at HAIL told PBI that open architecture has always been a key feature of their hedge funds panel.
"We mainly construct portfolios using third party managers," Sultan says.
"There are cases where we invest in one of our sister companies’ funds. The threshold they have to pass is no different," Bolger adds.
Other recent trends Brown describes include an increase in the use of alternative investments as a percentage of portfolio exposure.
"Seeing the flows and understanding the advisers and their client bases, we see more and more advisers building portfolios of alternative investment funds and products than we have historically," he says.
"That really speaks of the need for alternatives to play a role in a portfolio, whether to generate a return, which is not always the easiest thing in these markets, or to dampen volatility. This is very meaningful," Brown says.
Hedge fund prominence
Tamer Farooqui, CAIS Director of Investment Solutions, told PBI that investors focussed on strategies with low exposure to equity markets in the first half of 2012. This is due to the current volatility of these markets, with multi-strategy funds – which consists of a mix of hedge funds in order to spread out risk – currently a popular choice.
Farooqui provided data gathered by CAIS to support these points. Approximately $4bn was invested in hedge funds in the second quarter of 2012. This brought net flows for the first half of 2012 to more than $20bn and total industry assets under management (AuM) to more than $2trn.
These inflows were largely based in firms with AuMs of more than $5bn, which follows a trend present in previous quarters. However, as a result of major investment in these high asset firms, the smaller firms have been hit with net redemptions, losing more assets than they are bringing in. As a result the asset management market is becoming increasingly unbalanced, says Farooqui.
Getting physical
Brown says the majority of the alternative investments on the CAIS platform are hedge funds and private equity funds. However, CAIS recently added the ability to purchase physical precious metals on the platform. "The reason is very simple; our clients are looking for ways to get exposure to physical gold, not gold-related financial instruments," he says.
"We found that a lot of our advisers have a strong demand for ownership of physical precious metals, primarily gold. They wanted to own and they wanted to own it in smaller denominations.
"So with the CAIS precious metals programme, an adviser can buy a thousand dollars or more in physical gold and then choose their vault of location, whether that be Switzerland, the UK, New York or Asia. It’s also liquid so they can sell it and it’s also available through a reverse auction at dealers and refiners, so their pricing is extremely efficient. We are providing institutional pricing to the smaller investor," he says.
For most UHNWs, hedge funds form the bulk of their alternatives allocation; Spectrem’s survey showed that hedge funds are owned by 47% of the UHNW sample group. The research says HNWIs were investing further in hedge funds and other alternative investment classes in an attempt to gain strong returns amid a sluggish economic climate.
$29bn made up of hedge funds
Sultan and Bolger say HSBC’s alternative investments portfolio is in line with this trend. "The large majority is hedge fund investments," says Sultan. "Just under $30bn is made up of hedge funds," added Bolger, "As a total business we are $35.5bn at the end of December 2011. Roughly $29bn of this is made up of hedge funds."
Sultan explains that the way hedge fund portfolios are delivered to clients varies at HSBC. "We set our business between advisory and discretionary. On the advisory side it is a lot more tailored, the client is selecting funds with our help; the allocation can look very different from a typical multi-strategy portfolio which we manage for our clients."
"On the discretionary side, we split between our segregated mandates – which can be quite customised – and our commingled funds, which are essentially fund of funds," he says.
Bolger adds that the typical allocation of alternative investments within private clients’ portfolios is 15 to 20%, though this varies across client segments.
Liquidity concerns
Sultan says that a typical HSBC client portfolio allocation to alternatives, although largely dominated by hedge funds, includes private equity estate and real estate.
"We have been bringing private equity solutions to clients since 1995, we have been bringing very interesting real estate solutions to clients for the past 7-8 years," he says. "There is a track record there for both."
HAIL has had notable success in the past few years purchasing high-profile commercial real estate for private clients in so-called club deals.
Since 2009, the HSBC Club programme has acquired more than $1.3bn in trophy office properties across the US.
Private equity and real estate are relatively illiquid investments. It can take up to ten years for investors to pull money out from these investments. A large part of the alternative investments market today is the ability for investors to withdraw their investments, and HSBC have taken measures to make funds more liquid to ease retraction.
Sultan says that HSBC provides solutions to clients willing to take a risk with the illiquidity associated with real estate, with potential rewards being large returns to clients with capital growth potential.
20% necessary returns
Bolger explains that HSBC is focussed on making the investments more liquid to speed up withdrawal.
"The tenure of these real estate investments is about 5-10 years, which is pretty illiquid," he says. "The next step is private equity, which is typically 10 years. Many of our clients are entrepreneurs and interested in private equity, what we are trying to do is take advantage of the back end of the liquidity curve that clients might have," he says.
"We are focussing on necessary returns of roughly 20% over the whole period to make it worthwhile. We want to have all this under one roof, to have the ability to deliver the spectrum alternatives to clients including hedge funds.
"We also want to bring in the quest for yield into the real estate base, but with the space for capital growth."
He added: "At the back end of the liquidity curve, for our private clients who have that appetite, there are some there asking for this on a regional basis. We are looking to deliver some powerful returns to justify that liquidity."
As turbulent times continue and markets remain hard to read, HNWIs are likely to keep hedging their bets and gamble on big returns in the alternative investments industry. Traditional investments will continue to suffer, but one switch in the macroeconomic climate could see the balance swing again, leaving things fascinatingly poised.
