TOL - 27th Oct, 2023
How to invest in alternatives: One of the fastest growing asset classes in Australia
Alternatives represent a fast growing and rich opportunity set for investors but you need to educate yourself to take advantage.
Make no mistake, alternative investment opportunities and managers are proliferating - rapidly.
Research conducted by Preqin in 2019 pegged the global alternative investment market at US$10.8 trillion in value, and expected it to grow around 10% each year until 2025. By that time, the market will have ballooned to beyond US$17 trillion in value.
Preqin also estimated that the fastest growth would be in the Asia-Pacific region, which would experience a compound average growth rate of around 25%. The reason for the outsized growth in our neck of the woods is the lack of penetration of alternatives compared to the rest of the world.
One need only look across the local investment landscape and observe the number of global alternatives managers that have decided to cast their rods into Australian waters to know that the research conducted by Preqin in 2019 is playing out in real-time as we speak.
But the questions remain. Is all of this good for investors? Are we better informed about alternatives, and how do we identify the best opportunities in a market that - for all its hard work - remains quite opaque?
For answers to these questions and for a critical assessment of how he selects the best opportunities in the alternatives space, I sat down with Michael Houghton, Chief Investment Officer at Lucerne Investment Partners.
Houghton's take is that whilst he has noticed an increased awareness of alternatives in the mainstream investor market, ultimately, little has changed regarding accessibility.
"What hasn't changed, which has surprised me, is the lack of availability for that more mainstream investor market.
We're still the only real liquid alternatives investment available that's in the retail space for that investment market, which has been quite surprising" says Houghton.
Perhaps more importantly, however, during the following interview Houghton clearly outlines his process for selecting managers. He also articulates how alternatives can help increase the return profile of a portfolio whilst at the same time reducing risk.
Note: This interview was filmed on Thursday, 12 October 2023. You can watch the video or read a summary of some of the key insights below.
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Key insights
Has the industry done enough to educate people about the opportunity in alternatives?
According to Houghton, there is a lot more to do:
There's a lot more work to do. Awareness is one thing, but actually ensuring that people understand what they're aware of is another.
He adds that there are a lot of funds coming into Australia but they’re still only offering options that are available to institutional investors, whilst liquidity – or lack thereof – remains a key factor.
A lot of them talk about liquidity but they're actually offering it on a very conditional basis.
What we've seen in the last few weeks is about $6 billion worth of funds being gated, meaning cancelling your ability to redeem from that fund because they were never liquid anyway.
Houghton adds that the simplest way to look at things from an education perspective is - if the underlying assets aren't liquid, then the fund can't be liquid.
That's something that investors need to keep in mind.
The other major concern of Houghton's is the lack of experience of some of the new fund managers operating in the space. He notes that many don't have the typical level of experience required or the capability to support what really can be a complex space.
How does Lucerne sort the wheat from the chaff?
When it comes to selecting managers, the Lucerne process doesn’t actually start with the managers at all. Instead, it starts with the themes that Lucerne wants to pursue for its portfolios.
First of all, we try to identify themes, things that we think are going to unfold over the near, to medium, to longer term that we want to participate in.
Once we've identified that theme, then we try to think about how you can actually invest in that theme, what sort of strategies are capable of exploiting the opportunity that we think exists, and how would you go about it?
Only after that part of the process is complete does the Lucerne team look for a manager that can actually deliver, or is already delivering, on that theme.
And whilst that process sounds straightforward enough, the Lucerne team analyses hundreds of thousands of data points and conduct in excess of 200 meetings a year with managers.
As for the non-negotiables when it comes to the managers themselves, Houghton identifies three:
1. The first one is that they do what they say they will do. It's such a common response and people talk about it all the time, but it's just a non-negotiable.
2. That they've got the capability. They haven’t just decided they're going to set up and operate a fund in private credit, but they've never worked or managed money in that space before.
3. They're actually going to deliver on the theme that we want them to deliver on. If they say they're doing private credit, we don't want to see them go out and start managing volatility futures. So again, it comes a bit back to doing what they say they would do, not just in performance, but also in how they go about managing the money and allocating those investments as well.
Helping investors understand the opportunity
When I asked Houghton what the common questions from Lucerne's investor base are, he highlighted 'risk' as a major theme.
In Houghton's words, "For some reason, the word alternative seems to denote risk to investors".
Human beings fear what we don't understand and, as Houghton talked about earlier, there is still some ways to go when it comes to mainstream investors understanding alternatives.
In the meantime, Houghton has evidence that he likes to share with investors about the role alternatives can play in a portfolio and how effective they can be. If should be understood, however, that Houghton isn't advocating alternatives in place of stocks or bonds, simply in addition to them.
He adds that "alternatives only need to be 10 to 15% of your portfolio to be able to achieve a meaningful contribution to its return and to reduce its risk. And we've done some research on that".
"To give a high level example, on a simple 60/40 (60% equities, 40% bonds) portfolio), if you reduce both of those by five and put 10% into alternatives - i.e. you've still got your exposure to equities and bonds, as well as a 10% exposure to alternatives - that will give you a 1% additional performance on your portfolio and will actually reduce your risk by anywhere up to about half a percent on the volatility.
So it's a good thing to consider in your portfolio construction" says Houghton.
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them with you.
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...
Expertise
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