Love them or leave them, alternative investments will soon be available to all investors, thanks to CSA’s proposed amendments.
But only liquid investments are eligible. That’s a problem, as argued at the annual Alternative Investment Management Association Canada debate, where speakers considered if liquid alts are the future of the alternative investment industry.
Arguing the con side, François Bourdon, chief investment solutions officer at Fiera Capital in Montreal, says liquid alts are merely “watered-down hedge funds.”
Citing Preqin research, he says U.S. alternative mutual funds delivered 3.2% in the last five years, compared to 5.2% for hedge funds. Further, liquid alts had a correlation with the S&P 500 of more than 80% during that period.
Josh Levine, managing director at BlackRock in New York, gives alts top marks for performance, saying that long/short credit has similar returns to, and about half the volatility of, Barclays high yield; likewise, long/short equity has about half the volatility of most global indices.
The 80% correlation with equities? Not accurate, says Levine, because the figure doesn’t differentiate between funds. Only about a third of alts seek low correlation (diversifying funds).
He concedes, however, that when equities trend upward, all return bets are off. The S&P 500 has an annualized return of about 12%, leaving hedge funds in the dust.
In the last year, hedge fund returns haven’t compared favourably to traditional 60/40 returns, but over the long term, they do, says Levine, adding that differentiated returns shouldn’t track indices one-to-one. If they do, “you have a fee problem,” he says, because a cheaper index fund would fit the bill in such a case.
He looks to alts to navigate a new market environment driven by responses to the financial crisis, such as fiscal policy and regulation.
It’s the economy, stupid
Current valuations demand the use of alts. “Markets are trading above their long-term averages in equities,” says Levine. “In fixed income, that’s only more true.”
For the classic 60/40 portfolio, BlackRock assumes a nominal five-year return of 3%. “That’s just not going to cut it,” says Levine.
Bourdon agrees alts have a place in portfolios when returns are so dismal. But he looks to other choices in the alternative space: private debt, infrastructure, real estate, agriculture and private equity. “Those are elements that are bringing something special to the game,” he says.
For instance, increased banking regulation has created private lending opportunities with good return. In agriculture, more demand for food coupled with less arable land means growers have to improve productivity and raise prices.
“In a low-nominal environment, you don’t want to be exposed to [only] one or two things,” Bourdon says, enumerating equity risk, interest rate risk and, for hedge funds, talent risk.
“Alternatives are stronger together,” he says, a tongue-in-cheek riff on a Hillary Clinton campaign slogan.
The way forward
Both debaters agree on the need for education.
“Understanding the investment offering […] makes for a more durable industry,” says Levine.
Despite the finer points of their arguments, both debaters welcome access to alts. Contrary to media hype, says Levine, alts are neither poison nor panacea, but a welcome first step in democratizing the markets.
Also read: Challenges for fixed-income investors