Alternative investments

Building Superior and Sustainable Portfolio Returns

18 April 2022 • 5 mins read
Building Superior and Sustaina

Investing into ‘alternative assets’ has evolved and grown tremendously since the 1980s, gaining widespread importance in the portfolios of the most sophisticated and largest institutional investors, and increasingly with non-institutional investors and holders of private wealth.

The rise of alternatives investing is primarily due to its ability to improve the risk-reward relationship for investors. Alternatives investments also hold much potential to generate superior risk-adjusted returns, and complement overall portfolio performance amidst the volatilities of the current markets. The success of alternatives in the last two decades is attracting ever-growing capital commitments and ‘dry powder’, driving continuous product innovations, evolving business models and crucially, competition for returns. There is therefore a certain urgency to build up a portfolio in this area to capture performance and build more sustainable portfolio returns.

What are Alternatives?

Alternatives investments are broadly defined as any financial asset that do not fall into any one of the publicly traded investment categories of cash, bonds, or equities. Alternatives assets are sometimes called illiquid or private assets as one of their key features is they are not publicly listed in markets or tend to have no active dealer markets.

Exhibit 1. Key differences between traditional and alternative investments

Traditional Investments

Alternative Investments

Liquid investments

Largely illiquid investments

Numerous and passive owners

Active owners

Highly regulated

Less regulated

Extremely correlated with, and sensitive to, market movements

Low correlation to public markets (asset class dependent)

Open to general public and accredited investors; low investment amounts allowed

Only open to accredited investors; high minimum investment requirements

Source: Preqin Ltd.

Amongst these characteristics, we want to highlight three that we see as defining for alternatives: illiquidity, activism, and limitation to access. These attributes represent the additional risk premia and contributors of higher expected returns when investing in alternatives.

  • Alternative investments typically involve capital commitments over a longer time horizon and hence investors will be faced with lower liquidity in expectations of higher returns in exchange. The time horizon for a successful investment typically starts at 2-5 years for hedge funds, to 5-7 years for private equity and potentially longer for real assets
  • Unlike public market assets where investors who purchase the shares or bonds are essentially passive owners of the underlying companies, alternative investments are highly active investment strategies. Alternatives managers employ active management to grow valuations and improve underlying performance and earnings capabilities of their investments. In the case of hedge funds, portfolio managers are employing highly active trading strategies, combining a variety of market signals and financial instruments to exploit market inefficiencies and dislocations.
  • Due to the illiquid and complex nature of alternatives investments, they are typically accessed only by selected investors and crucially, those with the capacity to make larger sized investments. As the market for alternatives investments grow, this is an area that we can expect to see changes as financial innovations develop to reduce the hurdle of access.

Driving Synergies with Traditional Assets and Portfolios

Amidst the ongoing adjustments to inflationary and higher rates environment, investors should look into to alternative assets to improve the performance of their portfolio.

The various assets and strategies within the alternatives investment space have different returns profiles and characteristics that will shape its contributions to investors’ portfolios. It also gives investors ability to access niche and unique opportunities to access selected companies, businesses, sectors not found in the public markets.

Exhibit 2. Objectives for investing in alternatives assets

Objectives for investing in al

Source: Adapted from Preqin Ltd.

Incorporating Alternatives Require Additional Skills and Management

Investing in alternatives successfully requires having a balance of strong capabilities in due diligence with nimble decision making, and access to resources to build and monitor the right portfolios in a cost-efficient manner. The considerations and issues that investors would encounter include:-

  • There are limited low-cost index options in the alternatives universe except for commodities.
  • Many alternative investment options have a closed-end structure, especially top-performing managers or funds. Therefore, it is necessary to conduct continuous searches and due diligence for investment opportunities. Investors need to be able to access or acquire dedicated specialists to build and maintain alternative investment portfolios.
  • The private nature of most alternative assets demand greater scrutiny and continuous monitoring of contractual terms and requirements, fee formulas and other administrative due diligence.
  • Benchmarking and assessment of the performance of alternative investments require more in-depth expertise as information on the industry and performances are less readily available.
  • Many alternative investment options feature uncertain cash flows, which could limit investors depending on their investment goals

Investors should bear in mind that incorporating alternatives effectively into their portfolio would require more active management, higher costs and hence a broader skillset beyond the purchase and sale of publicly traded assets.

REFERENCES

Cohen, R (2018). Is Active Management Still Worthwhile? T. Mccullough & K. Whitaker, Wealth of Wisdom: The Top 50 Questions Wealthy Families Ask. (pg. 130-140), John Wiley & Sons

Preqin Ltd. (2020, November). The Future of Alternatives 2025

Important information
This product may only be offered: (i) in Hong Kong, to qualified Private Banking Customers and Professional Investors (as defined under the Securities and Futures Ordinance); and (ii) in Singapore, to Accredited Investors (as defined under the Securities and Futures Act) and (iii) in the Dubai International Financial Center to Professional Clients (as defined under the Dubai Financial Services Authority rules) only. No other person should act on the contents of this document.This product may involve derivatives. Do NOT invest in it unless you fully understand and are willing to assume the risks associated with it. If you have any doubt, you should seek independent professional financial, tax and/or legal advice as you deem necessary.

Please carefully read and make sure that you understand all Risk Disclosures, Selling Restrictions, and Disclaimers. This document must be read together with the relevant Prospectus & Offering Documents &/or Key Fact Statement.

Disclaimer
This document is prepared by Bank of Singapore Limited (Co Reg. No.: 197700866R) (the “Bank”), is for information purposes only, and is not, by itself, intended for anyone other than the recipient. It may contain information proprietary to the Bank which may not be reproduced or redistributed in whole or in part without the Bank’s prior consent. It is not an offer or a solicitation to deal in any of the investment products referred to herein or to enter into any legal relations, nor an advice or by itself a recommendation with respect to such investment products. It does not have regard to the specific investment objectives, investment experience, financial situation and the particular needs of any recipient or customer. Customers should exercise caution in relation to any potential investment. Customers should independently evaluate each investment product and consider the suitability of such investment product, taking into account customer’s own specific investment objectives, investment experience, financial situation and/or particular needs. Customers will need to decide on their own as to whether or not the contents of this document are suitable for them. If a customer is in doubt about the contents of this document and/or the suitability of any investment products mentioned in this document for the customer, the customer should obtain independent financial, legal and/or tax advice from its professional advisers as necessary, before proceeding to make any investments.

The Bank, its Affiliates and their respective employees are not in the business of providing, and do not provide, tax, accounting or legal advice to any clients. The material contained herein is prepared for informational purposes and is not intended or written to be used, and cannot be used or relied upon for tax, accounting or legal advice. Any such client is responsible for consulting his/her own independent advisor as to the tax, accounting and legal consequences associated with his/her investments/transactions based on the client’s particular circumstances.

This document and other related documents have not been reviewed by, registered or lodged as a prospectus, information memorandum or profile statement with the Monetary Authority of Singapore nor any regulator in Hong Kong or elsewhere.

This document may not be published, circulated, reproduced or distributed in whole or in part to any other person without the Bank’s prior written consent. This document is not intended for distribution to, publication or use by any person in any jurisdiction outside Singapore, Hong Kong, or such other jurisdiction as the Bank may determine in its absolute discretion, where such distribution, publication or use would be contrary to applicable law or would subject the Bank and its related corporations, connected persons, associated persons and/or affiliates (collectively, “Affiliates”) to any registration, licensing or other requirements within such jurisdiction.

Author:
Bank of Singapore Research
Was this page useful?