Blending of asset classes rewrites rules, puts everything up for grabs
The increasingly blurry lines between alternative investment classes — as well as between those investments and traditional stocks and bonds — have some managers predicting the term “alternative investments” will no longer exist.
Investors are cutting across asset classes to combine publicly traded and private investments and liquid and illiquid investments in a single portfolio with a single manager. Under this new approach, benchmarks are tossed out, often in favor of return hurdles.
These multiasset portfolios can be cheaper than individual alternatives portfolios, but pricier than a typical stock or bond portfolio. In this brave new world, everything is up for grabs and negotiation, industry insiders say.
Investors are being offered a wide array of strategies that combine investments previously in separate asset classes. A sample includes:
- “liquid alternatives” portfolios that combine asset classes including high-yield bonds, listed real estate, listed private equity and emerging market equities and bonds;
- private credit strategies, including bank loans and mezzanine debt, combined with publicly traded fixed income;
- hedge funds making venture capital, private equity and real estate investments;
- traditional money managers combining a hedge fund and long-only investments;
- private equity strategies that include equity and credit as well as liquid and illiquid investments;
- hedge funds that are trading infrastructure stock and master limited partnerships that provide a liquid option for allocations to real assets;
- hedge funds also offering long-only investments; and
- real estate debt being included in a private equity fund.
Still makes sense?
With more investment vehicles that defy asset-class definition hitting the market every day, some industry insiders question whether the term “alternative investment” still makes sense.
“Alternative investment managers” will disappear in about a decade, leaving only “money managers,” predicted James P. McCaughan, president, global asset management, and CEO of Principal Global Investors, Des Moines, Iowa.
“Portfolio management is not the same” as it used to be, Mr. McCaughan said.
Principal is working on investment strategies that are more focused, more absolute return and benchmark agnostic, he said. Those strategies combine liquid and illiquid investments, and active and passive investments.
Principal also has a strategy combining passively managed emerging market equity and debt with a hedge fund.
In the real estate area, some examples of convergence are real estate investments in multistrategy portfolios and collective investment trust-based multiasset strategies. “A symptom of convergence is a greater use of real estate in other strategies,” Mr. McCaughan noted.
Much of the convergence is being driven by the opportunities managers are seeing in the market, said Nicholas Tsafos, audit partner in New York with accounting firm EisnerAmper LLP.
One example is when midsize and small companies could no longer get financing from banks after the financial crisis. Alternative investment managers filled the gap, providing financing, he said.
“It juiced up returns,” Mr. Tsafos said.
Others in the industry say convergence is the result of investor actions.
“Things today are less neatly compartmentalized. It is less driven by asset managers, rather the needs of investors,” said Jacques P. Chappuis, managing director and head of solutions at The Carlyle Group, New York. “Some asset managers are not able to offer such sophisticated customization across multiple asset classes.”
Asset owners increasingly are trying to look at asset classes as packages of risk, Mr. Chappuis said.
“Investors are developing the understanding that any product is a package of risk factors and labeling them in artificial containers may not be the best way to choose the options that are out there,” he said.
Alternative investments are maturing as an asset class, said Peter Martenson, head of global distribution and partner in the La Jolla, Calif., office of placement agency Eaton Partners LLC.
Alternative investments are being pushed “deep into pension plans,” Mr. Martenson said. Private equity is moving into global equity allocations and bonds are moving into credit allocations that have both public and private debt in the same portfolio.
The convergence is being driven by the “consumer of products as well as consultants,” he said.
Traditionally private equity investments are long-term lockup vehicles — 10 years or more — and hedge funds have medium- to short-term lockups. But these distinctions are blurring, Mr. Martenson said.
Lockup periods now are being established to better match the duration of the investment, rather than to fit the traditional structure of a private equity fund or hedge fund, he said.
“One fund ... does (non-performing loans), non-performing mortgages. It looks like a hedge fund when you look at the terms, but on the other side it looks like private equity because there is no day-to-day trading and day-to-day liquidity,” Mr. Martenson said.
Asking for more
Investors also are asking their managers to do more for them as they trim their rosters of private equity and real estate managers.
“Clients across the board are looking to consolidate relationships, and I think consultants are also making some tougher decisions — meaning they are not just relying on diversification,” said Mark Attanasio, Los Angeles-based partner of credit management firm Crescent Capital Group LP. “They are making more concentrated allocations. And especially in areas where investment staffs are stretched ... why not increase the allocation to the firms that are providing better returns?”
Private equity managers are expected to invest in private equity and private debt, Mr. Martenson said. One example is a fund offered by Centerbridge Partners LP., a New York-based alternative investment firm, that contained half non-control debt and half control buyout equity in the same vehicle, he said.
“Nearly all private equity firms are trying to invest on the credit side to give their businesses more of an investment management patina to get the valuations they want,” Mr. Attanasio said.
But it's not just private equity that is in a state of flux.
Managers are beginning to develop blended vehicles for investors' allocations to real assets, which can include everything from infrastructure to Treasury inflation-protected securities. In the past, investors created portfolios of real assets by hiring different managers for each subasset class.
Investors have asked Morgan Stanley (MS) to create liquid portfolios of real assets, said Ted Bigman, managing director and head of global real estate securities and global infrastructure securities investing at Morgan Stanley in New York.
“Two of the new mandates we raised (in the first quarter of 2014) are a mix of listed real estate and listed infrastructure,” said Mr. Bigman. “Our mixed real estate-infrastructure capability includes active management of the allocation between the two categories.”
One attraction of a real assets portfolio is that there are not yet rivers of money chasing the opportunities, industry executives say. Less demand means investors can expect better returns.
Real assets is a fairly new global asset class that has been capital constrained, Mr. Martenson said.
And the real assets strategy includes a wide variety of investment options. Some oil and gas managers, for instance, are developing hybrid equity and debt strategies that include offtake agreements — a purchase-sale contract for future output, he said.
This article originally appeared in the June 9, 2014 print issue as, "The growing investment melting pot".