How has diversification in alternatives panned out? To a large degree, diversification has worked well. If you run your mind through the list of alternative investment classes that funds have diversified themselves into ... “all-star” commodities (have) proved to be quite a good hedge against turbulent equity markets. We're not saying it will continue forever, but it's nice to have some market that's an all star ...
On the other side of the coin you have property, although the commercial markets haven't been hit as bad as the securitized markets or the residential markets. Going forward, we think for funds that can afford to sell liquidity, (real estate) will be a good and attractive choice of returns ...
The private equity markets — clearly with the cost of leveraging increasing — is one area where we do counsel a bit of caution. The best-performing private equity managers can continue to add quite a bit of value in excess of what the public equity markets have. But the typical private equity managers have been able to make money through leverage rather than through skill.
Looking to hedge funds, with the cost of leverage going up, these will be more challenging times and we'll see further shakeouts in this market. Fees are very expensive and while it's not impossible for top-quality managers to add value, we'd rather they share a bigger portion of it with our clients rather than keeping it to themselves.
Hedge fund returns have been weak this year. Are investors growing disenchanted with investments? I think perhaps investors may be concerned with particular investments, but not the asset class or strategy class. The fact is that most investors still are underdiversified. The concentration of reliance on equity risk premium is still paramount for virtually all funds and Watson Wyatt, among others, still is very much encouraging funds to better diversify their programs ...
This is a difficult area. Skill is more transient than beta; the fact is that the equity risk premium we have has a positive value. Skill, on the other hand, almost by definition has zero or a negative value associated with it. So unless you're going to be a bit better than the average investor, you're not likely to succeed here.
Is the trend to LDI picking up steam in the U.S.? We see LDI has moved past the stage of any controversy whatsoever and what you have is the internalization that this is the natural position for a fund ... most if not all larger funds have gotten to here. LDI doesn't mean exiting equities and just moving to all liability-matching investments, it's much more about a philosophy and a framework than it is about cash matching.
We think LDI is here to stay; certainly as a framework and very much so as an investment style for a large number of corporate funds. But if there is some movement in (Governmental Accounting Standards Board) accounting, just you wait — there'll be sea change on behalf of the investment of government funds as well.
The U.S. real estate market looks pretty glum. How are you advising clients on investing their real estate portfolio? The ability to strike quickly is pretty critical here. We look to our higher governance clients to be able to take advantage of individual opportunities as they arise. We do think this is not likely to resolve itself terribly quickly and so there will be opportunities for months, if not years, going forward. There are also opportunities abroad. Clearly, emerging market real estate — to the extent we can find good vehicles that give our clients access — is a play on emerging market economies that may be attractive.
The era of the big deal in private equity is over. What's the outlook for this asset class? Over is a strong word. Asleep for a while; or perhaps taking a nap. This is a more difficult market for private equity than it was 12 months ago. We do think that the best private equity managers will be able to continue to add value going forward. A part of what makes them best is their ability to be nimble; they've built up excellent relationships and they have a very strong sense of what it takes to keep their best people engaged, occupied and adding value. At this point, we think there will be greater bifurcation in terms of the marketplace. The cream of the crop will continue to produce extra-normal returns but those generating normal returns using leverage will find it very challenging to make a good economic case for their efforts going forward.
“Real assets” are very popular as inflation hedges. What do you advise clients? First, you want to make sure you have inflation to hedge. For many pension funds, inflation is great as you will be deflating fixed promises you have made to your retirees. For other investors, inflation hedging may make a lot of sense. What we would encourage is for the truly long-term investor to take a long-term view with regards to some of this. The thought of timber in particular is clearly (for) a long-term investor (only) — there's not a lot (to be gained) in the short term. So, choose your inflation hedge carefully, make sure it is in line with what you need to do and what you want to do, and pursue it as a strategic part of your portfolio.
Some people think this could be turning point for the dollar. What's your view? As someone who goes overseas a dozen times a year, I hope so. One, against developed currencies the dollar has sunk quite a long way and probably a bit more than the fundamentals indicate. We haven't done anything really about the trade (imbalance). The consumer correction in the States has happened to some degree, but we have a farther way to go. Have they really (curbed) spending yet? No, they've not. Thus, while the dollar may be a bit oversold, it doesn't appear to be the world's biggest buying opportunity either.
What do you think a McCain or Obama presidency would mean for retirement plans? Given how likely it is the Democrats will retain control of the Hill, an Obama presidency (may result in) more defined benefit favorable legislation actually getting passed ... A McCain presidency with a very Democratic Congress — it's just very unclear what we could see.
Contact John D'Antona at [email protected]
