Written by Bill Blain, Strategist and head of Alternatives at Shard Capital
The Alternative Asset market has seen significant growth in recent years. Many institutional investment firms have built dedicated “Alternatives” teams. What are Alternatives? It’s a catch all for any investment strategy that falls outside the traditional listed stocks, shares, precious metals, ETFs or funds.
Alternative desks typically invest in bespoke private transactions, structuring deals to achieve above market returns. They might use private and/or secured debt, private equity, bespoke property deals, securitisation, hybrid and convertible instruments, and derivatives to build these private deals, based around “real assets”. Nothing is off the menu.
In many cases these deals achieve returns far higher than those available in public markets, but they carry significant added risks – particularly in terms of liquidity. Because they are private and off-market, Alts are “less liquid” than listed stock and bonds. There is no real secondary market, and most investors expect to hold deals to maturity. If they have to sell, it will happen slowly at fire-sale prices.
In times of market stress and uncertainty – such as the market is currently experiencing – portfolio managers tend to favour more liquid investments, concerned about the ease they can convert investments into cash in a crisis. While FTSE 100 stocks can be traded minute to minute, alternative private debt may take weeks for an investor to model and to value its inherent risks.
In return for accepting lower liquidity, the returns can be significant. Let me cite an example; most airlines don’t own their own planes but rent them from leasing companies. The monthly rental creates a predictable income stream paying interest, while selling the plane at end of the lease repays principal. The price of older planes is quite predictable. It’s possible to create double digit bond-like returns on an aviation deal – if the investor is prepared to accept the risk the airline might default, or the aircraft won’t sell at the end of the lease.
But there are always snakes and ladders in any investment game.
Snakes would include investors who bought into the Super-Jumbo Airbus 380, expecting they would be adopted around the globe. Sadly, they miscalculated; the planes were too big for most airports and not efficient for smaller airlines. Nobody wanted them after the big airlines were finished with them. The big airlines simply handed back their early A-380s, and since there were no other users, 10-year old planes in nearly new condition were scrapped.
But then we got a ladder. Boeing and Airbus were hit by massive supply chain and labour issues due to Covid and have been unable to deliver the new aircrafts that were supposed to replace the A380s. As a result, suddenly airlines are refurbishing and extending the leases on remaining Super-Jumbos. All older aircrafts are rising in value because of the shortage of new ones – so we’re putting together a diversified portfolio of planes operated by a range of airlines to diminish the underlying risks. Understanding the demand/supply mechanics of the aviation market can lead to a very successful alternative investment play.
Any investment professional will explain the importance of a well-diversified portfolio. Alternatives can add a further element of diversity, but they are more difficult to monitor – and are certainly not for retail investors to manage except through an experienced investment fund professionals.
It’s all about understanding how the underlying asset will perform. One fund in the news is Hipgnosis, a fund set up by Elton John’s former manager to invest in music rights. The thesis was enhanced shareholder returns would come to owners of music royalties as streaming reduced music piracy. The fund acquired a whole list of famous artist portfolios, paying millions for their back catalogues. But now the deal may be struggling – revenues haven’t been as attractive relative to the rising yields on government bonds, the Net Asset Value of the portfolio has crashed and analysts say the prices Hipgnosis paid look overvalued.
To add insult to injury, the firm appears to be cherry picking its portfolio to sell the best assets to its partner hedge fund, leaving the other investors with the less well performing assets. Many music professionals reckon Hipgnosis overpaid for assets, but the firm was able to convince investors its pricing made sense. It illustrates that without expert knowledge investors can’t be expected to understand the sustainability and predictability of its cash-flows. Pink Floyd may still be popular today, but what about in 30 years’ time? Will music lovers still be downloading, or will the fan base have passed away?
Music backed deals are not new, they were originally called “Bowie Bonds” after David Bowie used them to monetise the value of his catalogue back in the 1980s. (His music continues to stand the test of time, others not so much.)
Another trap to avoid is off market mini-bonds. Retail investors have been sucked into bad “alternative” deals. The losses suffered by retail investors in London Capital & Finance “mini-bonds” illustrate the risks of fraud when managers are trying to push off-market investments. As a result, IFAs are nervous to propose alternative investment strategies to clients because of the risk of giving poor advice. But, it’s certainly worthwhile thinking about how alternative investment strategies could raise returns across any portfolio.
Listen to our recent discussion with Bill Blain on IFA Talk below: