reading

Contents

Cover

Half Title page

Title page

Preface

Acknowledgments

Chapter 1: What are Alternative Assets?

Are Alternative Assets Really “Alternative”?

Thoughts on Classification

Chapter 2: Investing in Alternative Assets

Why Should We Invest In Alternative Assets?

The Traditional Worldview

Problems Posed by the Traditional World View so Far as Alternative Assets are Concerned

Problems With Liquidity

Active and Passive Investing – Beta and Alpha

The Rationale for Alternative Assets

Chapter 3: Real Estate

Real Estate Beta

Real Estate Exposure

Synthetic

Chapter 4: Energy

Spot Trading

Influences on Pricing

Accessing Oil As An Investment

Bio-Fuels

Natural Gas

Oil and Gas Royalties

Energy As An Investment

Chapter 5: Private Equity

Private Equity – Definition and Types

Development Capital

Venture Capital

Mezzanine

Quoted Private Equity

Private Equity Funds

Private Equity Returns

The J-Curve, IRRs and Multiples

Vintage Year Returns

Funds, Funds of Funds and Secondaries

Concluding Thoughts on Private Equity

Chapter 6: Hedge Funds

Introduction

Use of Derivative Instruments

Leverage

Some Common Elements

How Hedge Funds Invest – An Overview

Specific Strategies

The Hedge Fund Model – Pros, Cons and The Future

Some Final thoughts on Hedge Funds

Chapter 7: Infrastructure

What Is Infrastructure?

Drivers

Government

Threats

Quoted and Unquoted Infrastructure

Returns

Chapter 8: Commodities

What Are “Commodities”?

How Can We Classify Commodities?

What Are the Return Drivers?

Commodities Beta

Commodity Returns

The Case for Commodities

Chapter 9: Gold

Introduction

Fixing the Gold Price

How to invest in Gold

Chapter 10: Active Currency

How Can An Investor Make Money By Investing in Currency?

Institutional Approaches

Active Currency Strategies

Active Currency Beta

Final considerations for active currency

Chapter 11: Other Alternative Assets

Forestry

Gem Stones

Works of Art

Musical Instruments

Antiques

Wine

Classic Cars

Other Collectables – Coins, Medals, Stamps, Militaria, Snuff Boxes, Perfume Bottles, etc.

Yet More …?

Conclusion

Index

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Library of Congress Cataloging-in-Publication Data

Fraser-Sampson, Guy.

Alternative assets : investments for a post-crisis world / Guy Fraser-Sampson.

p. cm.

Includes bibliographical references and index.

ISBN 978-0-470-66137-6 (hardback)

1. Portfolio management. 2. Investment analysis. I. Title.

HG4529.5.F7458 2010

332.6-dc22

2010039908

A catalogue record for this book is available from the British Library.

ISBN 978-0-470-66137-6 (hardback), ISBN 978-0-470-97688-3 (ebk),
ISBN 978-0-470-98008-8 (ebk), ISBN 978-0-470-98009-5 (ebk)

Preface

The events of 2007 and 2008 have had many consequences, shattering as they have many of the old “certainties” by which the world’s investors were happy to live out their lives. Fundamental questions are now being asked, throwing into question the very validity of much traditional finance theory. Even more fundamentally, we are being forced to confront disturbing new issues, such as the very meaning of words such as “return”, “risk” and “value”.

In truth, though, many of the world’s investors were not even applying the precepts of traditional finance theory, though they may have paid them lip-service. The requirement for a properly diversified portfolio, for example, while a matter of simple common sense, was routinely ignored, even by those, such as UK pension funds, who had a legal, rather than simply a professional, duty to comply.

Yet it can be mathematically proven that what has become known as a “Yale type” approach (which really means little more than having a properly diversified portfolio), a concept much closer to that practised by North American pension funds, would have dramatically lessened the impact of the various financial shocks and stresses of the last quarter century or so.

Whatever the case, the recent financial crisis must surely have brought home to even the most obdurate investor that the “all your eggs in one basket” approach really is as foolish as it sounds, and that the imperative for a sensibly diversified portfolio of different asset types can no longer be ignored.

That means Alternative Assets, at least if we are going to apply that label (as most investors seem to do) to anything other than bonds and quoted equities, and here we run into an immediate problem. There is an old adage,1 and a very good one, that you should never invest in anything you do not understand. Well, no real level of understanding of any Alternative Assets currently exists in the vast majority of the world’s investment institutions. That means that unless they are going to invest blind in Alternatives then they need to gain such knowledge, and quickly. Those who actually possess that knowledge, particularly across various asset types, will cease to be regarded as mild eccentrics roaming the outer reaches of the investment world, and begin to be recognised as useful and, therefore, valuable individuals.

This book is an attempt to pass on at least some of that knowledge. Each chapter provides useful background knowledge on a particular asset type, including a discussion of whether a satisfactory beta return level exists and, if so, the different ways in which it might be accessed. While the author is a well-known advocate of Alternative Assets, it is in no way the intention to showcase their merits, nor to downplay their potential drawbacks. To suggest that all Alternative Assets offer exciting opportunities for all investors at all times would be nonsense. There are some that struggle to justify themselves on a returns basis, and others that offer significant difficulties of implementation. These issues can only be resolved by individual investors around the world having due regard to their own particular circumstances. There can be no valid “one size fits all” approach.

This introduction will be brief, not least because experience suggests most readers will have turned straight to Chapter 1, but four important points fall to be made.

The first is that all this book can do is to impart “knowledge”, not experience. There is an important difference between the two. As a hugely successful investor2 once pointed out, no fish can imagine what it is like to be a mammal. One day of walking around on land is worth two thousand years of writing about it. As business school students quickly realise when they go out into the world of investment, there are certain situations in which financial theory seems to work very well, and certain situations in which it seems not to work at all. Understanding that theory offers certain guidelines, rather than a rigid framework within which the “one right answer” can be calculated is an important step, and one which sadly many investors are never able to take.

The second is that readers will find certain issues popping up in more than one chapter. While it would have been preferable to split these out into separate sections of their own, this has not always been possible, since the same issue can impact different asset types in different ways, or raise different practical implications. Thus, while every effort has been made to discuss as much common matter as possible in Chapter 2, there are some things which will regularly intrude. In particular, the issues around (1) counterparty derivative risk, (2) difficulties of physical possession and/or use of spot pricing, and (3) the inappropriateness of using a basket of operating businesses as a proxy for asset or project exposure.

The third is that, while what might be called traditional financial theory, which may be loosely described as everything and anything which is based upon the assumption that the risk of an investment and the volatility of its historic returns are one and the same, appears to the author to be, at the very least, open to many objections, its validity will be assumed for the purposes of this book. Thus, investors will be able to move freely within their chosen world, in which volatility is uniformly bad and liquidity is uniformly good, in which the past is always a good guide to the future, and in which normal distribution will always apply. Those who have been diligent enough to read this introduction will, however, be punished for their thoroughness by having these sentiments repeated in the body of the book. It is only fair to point out, though, that anybody who slavishly follows these precepts will find it difficult ever to countenance an allocation to many Alternative Assets.

The fourth and final point to record is that in this book there will generally be reference to “asset types” rather than “asset classes”. In part this is a desire to avoid loose terminology. There are many who now question whether Private Equity and Hedge Funds, for example, are really “asset classes” at all. While this may prove a fascinating discussion, it is not one which we need to pursue between the covers of this book.

In part though, and more importantly, it is an attempt to bring home to readers that actually it almost certainly is not important what any asset is called. That is part of the human compulsion for classification, to apply a label to something and place it in its appropriate pigeonhole. A compulsion, incidentally, which has caused great problems in the area of Asset Allocation. No, what is really important is not what an asset is called, but how it might perform within an investor’s portfolio.

Guy Fraser-Sampson

Cass Business School, City of London

October 2010

1 Usually attributed to Warren Buffett.

2 Warren Buffett again.