The last decade has been a very poor time for all those funds which bought and held US, UK and European equities. Funds have lost money over a whole ten year period. The old theory that all you had to do for a charitable fund or long term pension fund was to buy and hold equities has taken a knock.
The position in Japan has been even worse. The market today is around one quarter of the level it reached in 1990. It has never been back anywhere near the 1990 high for two decades.
In recent years many funds were persuaded to buy into a range of alternative investments. These were actively marketed and offered apparently much higher returns than conventional share portfolios. Larger funds invested in commodities, in property, in hedge funds and in private equity. These asset classes were said to move differently from stocks and shares, so they apparently offered diversification. If shares fell, the theory went, your portfolio might still benefit from the alternatives.
In 2008 commodity prices fell, property prices fell and private equity entered a very tough time. Most alternatives were damaged by the very same things that hit equities. If credit dries up and people become risk averse, private equity, property and commodities will suffer just as surely as snare. Many hedge funds also went down. They too depended on borrowing, and needed some markets to be rising. Only the funds which specialised in shorting shares or a few other exoteric strategies avoided the downturn.
During the dislocation many funds discovered that their holdings in private equity and property were very illiquid. If you owned these assets directly, you were locked in as there was little secondary market for private equity company shares or for second hand properties. If you owned them indirectly through funds you were also illiquid. Many of the funds both cut the stated asset values rapidly in response to the collapse, and made it difficult or impossible for investors to obtain an early exit from their holdings. Funds experienced the illiquidity, but did not benefit from superior returns to pay for that extra risk and inconvenience. Even some of the commodity funds were difficult to get out of. They suffered badly from the price collapse.
Looking at the modern investment universe, we do not think 2008 proves it is wrong to invest in property or commodities or private equity. Each is different. There is a lot to be said for a stream of income from rent which is a prior charge on company income, which in normal conditions rises. It is likely as 2.5 billion Chinese and Indian people grow richer that there will be strong demand for more commodities on a scale not seen before. Private equity can be a good way to improve company performance, and it should be possible to benefit from turbo-charged corporate performance which comes from the incentives and short lines of command in those companies.
However, we think there were also warnings in the 2008 experience. It does lead you to ask if you want to be locked up in assets you cannot sell at a decent price if things turn bad or if you change your mind. The fee structure on many alternative products is generous to the managers at the expense of the investor. That is why we favour investing in alternative assets through vehicles which are much more liquid.
There is now a range of ETFs which can take care of the need to invest in a wider range of asset classes, but in a way which is as liquid as the share market. The ETFs in property buy portfolios of quoted Real Estate Investment Trusts, offering a better yield than the average share yield in the comparable market place. The ETFs for commodities keep most of their money in low risk short dated instruments, with the commodity exposure limited to options to ensure the fund matches the commodity index. The private equity ETFs buy into the quoted shares of the main private equity companies, which in turn own shares and incentive packages in their target companies.
An ETF shareholding can be bought or sold in a minute using the normal share exchange. If liquidity in that particular ETF is limited on a particular day, the manger of the ETF will buy or sell the shares, creating or destroying units, by buying or selling the underlying shares in the fund.
Evercore Pan-Asset would be happy to design and run a portfolio of suitable alternatives for larger funds. We could offer something that should be more liquid and lower cost than direct or specialised active fund investment, and something which is more liquid. The aim is to match the relevant property or commodity or private equity index.
We would be happy to discuss this with you or send you a proposal. Now we have had a good rally in share markets, it is a good time to be thinking about this type of diversification. None of it will be Credit Crunch proof, but it can give you a better and rising income and scope to beat the share blues which we have experienced over the last decade in advanced markets.