A LARGE PROPORTION of investment vehicles are now so complex, it is unlikely boards will ever be able to understand what they are investing in, according to one super fund manager, but others say there is often an irrational fear over so-called alternative investments.
Tim Hughes, chief investment officer at Catholic Super, told an investor conference in Sydney last month that his fund had 25 per cent of its funds in “alternative” investments, such as hedge funds, but he said these weren’t the most complex vehicles.
“The most complex investments that we have are sitting there on the listed equity markets,” he said. “I think the average top-100 company in Australia has a little bit more than 30 subsidiaries.”
Stapled securities, for instance, he said are somewhere between trusts and companies. “Typically, stapled securities could have up to 300 controlled entities,” he said. So simply working all the fees that were being drawn was a challenge.
“I think this issue of complexity goes right across all investment portfolios. Complexity is really only limited by the human imagination,” Hughes told the Terrapinn Asset Allocation Summit.
“We have had a generation of complex greed products, and I am sure we are now going to have a generation of complex fear products.”
He said this meant it was sometimes hard for investment professionals to understand many of the listed entities, so it was very difficult to explain them to their board, let alone their investors.
Robert Walton, CEO of the Claremont University Consortium in the US said going into so-called alternative investments had been worth it for his institution, and said it was important to look beyond the bad press hedge funds and the like were receiving.
He said there had been a big investment of college endowment funds into alternative products by the higher education sector in the US, first by the Ivy League universities, and their big returns had prompted smaller institutions to follow suit.
“Travelling around the world … I realised we have much bigger asset allocations in alternatives than any other part of the world,” he said. This was in large part due to the relatively low level of public funding in US universities.
“Most of my peers all [have allocations of] about 50 per cent in alternatives – hedge funds, private equity and venture capital.”
Despite a lot of negative publicity about these supposedly riskier investments, he said his university, and many others, had gone into these not to increase risk, but to mitigate it.
However, he said there were numerous factors that made these riskier investments, and if these were apparent it was best to not invest. In fact, he said “95 per cent of the hedge funds are crap”, and these were the ones that had created the bad image. But the 5 per cent left were worthwhile investments. “Most of the organisations in the hedge fund community are not really set up for good risk management,” he said.
It was particularly important to avoid highly-leveraged funds, and he said he engaged in hundreds of interviews with fund managers to ascertain the nature of the fund and the talent and intentions of the people running it.
“We have got to do a lot of due diligence on when to get out. If some of the key people change, you just get out,” Walton warned.
When going into alternative investments, organisations also had to ensure they had a “very tight control of PR” as one of the biggest risks was negative headlines, which commonly have a direct impact on market fears, especially the prejudices associated with hedge funds.
This negative perception of alternatives extended to external auditors. “The auditors at the major audit companies are so nervous about the alternative investments, and the inability to value them [as] they can change on any particular day.”
This then causes some board members to worry because they could not “understand why they were not getting a 100 per cent, squeaky-clean audit and it does affect your credit rating.
He said one article in BusinessWeeklooking at the move of small universities into alternative investments had focused on the risks they were taking, but he had managed to follow it up with an article in a national newspaper on the benefits of theseinvestments for his university.
“You just get beat to hell on these investments when something goes wrong,” Walton said. “You can just step back and the market drops and you are seen as just a victim. If there is the slightest glitch, if somebody uses equity trading in a headline, then you can really be pummelled.”
Walton said it was also important to have prepared a good “elevator explanation” to the board and auditors. “You have got to have a prepared three-minute explanation of how you are doing these investments.”