Families in Business chaired a roundtable discussion at Campden's Family Alternative Investment Conference to discuss whether now is a good time for families to purchase AIs, the growing impact of green investments and the asset classes to look out for.
Is now a good time to purchase alternative investments and, if so, why?
Fred Fruitman: In terms of the spectrum of things you can invest in, now is a good time to invest in alternatives, 10 years ago was a good time – it's always been a good time to invest in alternatives. I think some families are just discovering them now, but great investors have always invested in alternatives.
The problem is that you don't want assets that are over- or fairly valued, you want assets that are under-valued. Those of us who got into the investment business after 1982 have seen a 25-year run of excessive returns. And the main reason for that excessive return has been private equity expansion.
Is now a good time to be in private equity? There's a lot of money in there, but firms pay high prices and you'd think that means ultimately lower returns. However, private equity firms are currently competing with the strategic buyers, which is unheard of.
Real estate is another story. I think it's a regional business and it really depends on the economies of the places you're going into. I think you could probably do well investing in real estate in Bangalore if you know what you're doing, but I wouldn't want to be investing in Manhattan right now.
Kimberly Tara: Yes, now is a good time, but I think we need to take a step back as what we're talking about is asset allocation, what your objectives are at portfolio level and to what extent alternatives or other asset classes and asset management tools add value.
Questions that we should be asking include how best to link asset classes together (depending on your objectives), how aggressive you should be with your time horizon as an investor, whether you are looking at income needs because you're a family office or whether you're looking at liability matching because you're a pension fund, and how that fits into the return for funds that are available from some of these newer asset classes.
Then there's a risk question. There are many different options in terms of how you access some of these newer asset classes and the contribution they make to risk management at the portfolio level.
Tom Idzorek: The past was the right time, now is the right time and the future will be the right time to be in alternatives. When it comes to asset classes, I object to the word "alternative" – to me we're investing in assets and the term alternative confuses people. It's important to separate alternative asset classes, such as real estate, commodities and private equity, which are true asset classes, as we don't really need to have the word alternative attached to them.
Asset classes are asset classes and I believe large opportunity sets lead to better diversification. When it comes to the use of "alternative manager formats" to gain exposure to the asset classes, such as managed futures or hedge funds, it is less clear whether or not investors have skill at selecting good active managers.
Karim Daou: Since 2000 we, along with our families and investors, have focused on a category of alternative investment called absolute return investment. Whether it concerns a global asset allocation or a geographically focused orientation, the objective is positive performance regardless of any negative performance of the underlying. As we manage absolute return investments as a crossroads between hedge funds and mutual funds, it should always be a good time to purchase them.
For example, 2005 was a very good year for hedge funds in Japan, but in 2006 they ended the year with a strong negative return. An absolute return on the other hand, such as 788 Japan Fund, ended 2006 with a positive return because timing is not a concern for this type of alternative investment.
Do you see green/environmental investments as sustainable or are they just short-term trends? Also, are there returns there at the moment?
Tara: It's very important to distinguish between green investments and sustainable investments in the environment. Green investments are often investments where you take a particular category and you invest in the greenest one.
When we talk about sustainable investing, which is much more the long-term environmental side, you see something more. You say, "I'm in this to both help the environment and make money." That's a more long-term business decision with an investment objective to also target the environment.
Fruitman: If something's a good investment on its own, and it happens to be involved with the demand that's created through environmental concerns, it's a good investment.
But there was a time I remember back in the late 70s when the price of oil started to go up and all these schemes appeared with the aim of reducing our dependency on oil.
Then the oil price went down and the schemes all disappeared, which leads you to believe that if something is not fundamentally a good investment on its own, it then becomes a fad. Ultimately, this green phenomenon will only succeed if it turns out to be profitable because there is a real need for it or because it is legislated for.
Idzorek: I guess I'm a little pessimistic. I share Fred's view that if it's not economically viable on its own merits then it's probably going to be a bad investment. I very much want for green to succeed, but it will only succeed if it makes sense economically.
Daou: I hope to be optimistic; I think the situation today is better than it was in the 70s in terms of people understanding the need for green investments.
I'm currently looking into eco-friendly companies in China. There are very few of them and China has great potential for such companies to grow and provide real value. The difference is that they are backed up with a long-lasting economy and, therefore, the value of the investments is stronger.
If a family wanted to look into investing in green alternatives, what is the best way for them to explore this avenue?
Tara: It depends what their objective is. If their objective is to have a certain risk return profile that is also green or in some way neutral/positive for the planet, then I would say you need to look at what investments will offer you this mix.
I don't think you could start on the other side saying I want to buy a company and expect that it would also be a green investment. You really have to start at the portfolio level and, as with any investment, ask what its role will be before adding to that role the fact that you'd also like it to meet certain ethical criteria.
Idzorek: Well, I think you can certainly do it. A sound investment plan begins with a strategic asset allocation policy, the familiar beta decision. Next, you arrive at the alpha or product decision. You would then limit your investment opportunity set of investment products to meet your green criteria.
This will be easier to do in some asset classes and more difficult in others. In some cases, limiting yourself to green investments will impose an artificial constraint on the portfolio construction process, which may result in a reduction of possible investment performance.
Fruitman: We have a lot of beneficiaries over the four generations that we look after. Some of them have made these types of green investments, but we probably wouldn't do it from the top down.
We think it's an individual's decision and if somebody has an interest in that then we'll help them to evaluate it and make sure it's a viable type of investment, but I don't think it would form a strategy because we're measured on performance. If we start making constraints on our portfolio construction it's certainly going to affect our performance stats.
Hossein Kazemi: I think that's an important issue: what is the true cost of putting that constraint on performance? There is some evidence from socially responsible investment vehicles that, although initially they didn't attract a lot of capital, after the bubble burst in the NASDAQ they held up quite well because they tend to be value stock.
Then they saw the rapid inflow coming in, so investors realised that the cost of imposing restrictions is not as significant as at first thought and they should hold up pretty well during a recession.
Just a few weeks ago, Christopher C Geczy, assistant professor of finance at the University of Pennsylvania's Wharton School, completed a study in this area to measure the cost of imposing such restrictions. Of course, one person's view of social responsibility is different to another person's, so he used various criteria, but he came to the conclusion that it is actually becoming a viable investment class. The skills of alpha managers in this area are going up and because the amount of assets being managed has increased, it is beginning to attract talented money managers.
If I were to put you on the spot and ask you which alternative asset class is the one that you would tip as being the one to watch over the next 12 months, what would you say?
Tara: That's easy for me, commodities and natural resources.
Kazemi: If we're talking about truly an asset class then I would go with commodities I think, maybe to some extent soft commodities and soft metals.
Fruitman: It's a tough question. If you sit back and ask yourself what's the craziest thing that's going on right now then you would say private equity funds paying ridiculous prices for assets. If you had to be a little contrary I'd say let's take advantage of the fact that they are going to over pay.
Daou: For me, the absolute return investment is the most appropriate.
Idzorek: I'm not going to predict one. Over a short time period, it is very difficult to predict which asset classes will be the best performers. Investors should diversify their
portfolios over a large number of asset classes.