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Five reasons why you should invest in alternative assets in the UAE

Five reasons why you should invest in alternative assets in the UAE

Alternative assets include property, real estate investment trusts (REITs), private equity, venture capital and hedge funds

As an investor, you’re likely to encounter hesitation around alternative investments.

First, from your clients, for whom investing in what feels like ‘the unknown’ may not sit easily.

Second, advisors may hesitate too. While you have your clients’ best interests at heart, as you develop successful ways of working it becomes less and less in your nature to deviate from what you know and trust.

This is a shame – you could be closing off a wealth of underused opportunities for your clients.

So let’s examine five key facts about alternative investments and allay those fears.

1. Strong diversification potential

As an experienced professional, you will know that alternative assets are often defined not so much by what they are as by what they’re not. For example, the Financial Times describes them as ‘any investment that does not fall into the traditional asset classes of stocks, bonds or cash’.

It’s a useful approach, because the range of investment types populating the ‘alternatives’ bucket can be exhaustive.

Understanding the ‘alternatives’

When we talk about alternative assets, we might mean property – directly owned, real estate limited partnerships, real estate development corporations, or real estate investment trusts (REITs). Other alternatives include private equity, venture capital and hedge funds. The banking disengagement since the 2008 market crash opened up several sectors to private investors.

We could be talking about commodities: precious metals, crude oil, natural gas, and everything from coffee to cobalt. Let’s not forget intellectual property or a whole host of specific categories of value such as rare wines, valuable coins, fine art, or classic cars.

Traditionally, alternative assets have a tendency to be illiquid – many aren’t publicly priced or traded, such as limited partnerships, collectibles, antiques, and many holdings of hedge funds. But that’s not true right across the broad spectrum of the term and investors can get exposure to alternative assets through closed-ended companies like investment trusts, which offer instant liquidity.

In addition, many experts believe that the illiquidity itself is a justified risk, offering attractive returns for the risks assumed.

How to approach diversification

We know that diversification is a key principle of portfolio building – traditionally, investors might use equities and bonds to provide a natural counterbalance to one another. But it doesn’t always work and when interest rates are low, alternative assets can provide a way to offset equities with higher returns than bonds. They seem to be popular: research suggests total global assets managed by the top 100 alternative investment managers reached $4 trillion in 2017.

2. Little or no correlation to the rest of the market

To be useful, the diversification built into any portfolio has to be functional. The asset allocation must flex and respond in a way that is complementary – while some fare badly, others need to be doing well. Alternatives that invest in currencies, commodities and real estate typically have low correlation to traditional stocks and bonds.

Some asset classes are immune from the markets and investors’ feeling, sourcing their performance drivers from factors such as climate, longevity and the legal field.

How low correlation helps reduce portfolio volatility

Take commodities: as ‘real assets’ rather than ‘financial assets’ these raw materials can help to offset the effects of inflation. Demand leads to scarcity, which leads to inflation and commodity prices generally rise when inflation accelerates. Conversely, rising inflation tends to hurt fixed-income assets and equities, so adding alternatives to the mix can help reduce overall portfolio volatility.
The efficient frontier

Based on their risk appetite and tolerance, the investor should build an investment portfolio by seeking an optimum investment to get the best possible returns. When setting up their investment strategy and portfolio, the investor should design the best balance between risk and return, as shown in the below efficient frontier graph.

To achieve an optimal portfolio, diversification is key. Alternative and uncorrelated assets to traditional markets will have a significant impact on the portfolio’s performance. Alternative assets tend to behave differently than typical stock and bond investments, so adding them to a portfolio may provide broader diversification, reduce risk, and enhance returns.

3. Low volatility

While some alternatives, like venture capital and REITs, may well be volatile, others can be quite the opposite. Litigation funding, for example, is largely immune from market swings. With this type of investment it is possible to achieve returns across a portfolio similar to private equity, but in a shorter time frame.

Litigation funding involves investors allocating money to finance lawsuits. The majority of providers offer non-recourse funding, making it inherently risky for investors. However, choosing a capital protected fund offsets the risk via an insurance policy.

Making low-volatility investments available to your clients

Many alternatives are far less volatile than the average stock market asset. By making these low-volatility investments available to your clients, you can offer them a better-than-average level of confidence as well as the promise of healthy returns.

4. High returns

Analysis shows that alternative assets can generate stable, high levels of income. Private mortgages or private debt, for example, can see returns of 12 per cent per year. In a recent paper, JP Morgan found that ‘an allocation addition of core alternative assets as small as 5 per cent can significantly enhance portfolio outcomes.

Helping your clients enhance their returns

As an investment professional, it’s your job to invest and manage your clients’ money in a way that helps them grow their wealth and reach their financial goals. That means spotting opportunities to enhance the returns of the overall portfolio. Alternative assets provide a way to squeeze out that bit more potential return for your clients’ investment portfolio.

5. Reliable regulation

The long-standing notion that alternative investments are poorly regulated compared to more traditional asset classes no longer applies. Since the financial crisis of 2008 several key pieces of legislation have been introduced. These include the Alternative Investment Fund Managers Directive (AIFMD), which focuses on EU-based hedge fund management firms, and the Dodd-Frank Act, which supervises US-based hedge fund firms.

According to the Alternative Investment Management Association, ‘Increased regulation since the global financial crisis and adherence to industry sound practices have considerably strengthened investor protection and provided for greater transparency.’

Reassuring your clients on regulatory issues

Nowadays, alternative investment management firms must comply with strict standards around conduct, transparency and conflicts of interest. This should give your clients reassurance to invest in non-conventional but more fruitful assets.

Time to spread your wings

Alternative assets aren’t a whole new way of building portfolios – the traditional asset allocation frameworks around equities and fixed-income remain.

What they do represent, from a fund management perspective, is an exercise in going the extra mile and maximising, rather than just maintaining, client portfolios. It’s no longer the Wild West out there; alternative investments have been brought to heel, but their promise and diversity remain undimmed.

Marco Saviozzi serves as CEO of GMG brokers

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