“Against a backdrop of fairly high valuations of stocks and bonds, we recommend to diversify into alternative asset classes such as hedge funds, private equity and real estate funds,” Arnaud Tellier, Singapore-based head of investment services for Asia-Pacific at BNP Paribas Wealth Management, told FSA.
Alternatives serve as a mid-to-long term diversifier with the probability of achieving higher-than-average risk-adjusted returns compared to traditional asset classes, he said.
Tellier recommends allocating 5%-10% to alternatives as part of a client’s long-term strategic asset allocation, depending on the individual investment profile.
Similarly, Bank of Singapore recommends its clients increase alts exposure. Last year, the bank was recommending a 10% allocation to hedge funds, and has recently increased this to 14%, said James Cheo, the bank’s investment strategist.
Cheo noted that the bank’s definition of alternatives is just hedge funds, but it is now reviewing how it can broaden the definition so it could include private equity, real estate and commodities.
James Cheo, Bank of Singapore
Although Tellier and Cheo are seeing increasing demand for alternatives, clients who invest in the asset class are still under-allocated, while others are still grasping the idea of alternatives.
According to Tellier, most of BNPP Wealth’s clients’ portfolios are still underweight alts in general and below the recommended 5%-10% allocation.
For Cheo, although demand is growing, it is coming from a low base of clients.
“Last year was the education phase [for the bank] to help clients understand the benefits of hedge funds,” he said, adding that those who had allocated last year are seeing diversification benefits and are now allocating more to them.
“Equity market valuations are at an all time high, and quite a number of investors agree with the thinking that they need to go into alternatives to search for additional value that traditional assets can’t give,” Cheo said.
Hedge fund strategies
In terms of hedge fund strategies, BNPP Wealth’s Tellier prefers long-short equity and event-driven strategies.
“For long-short equity, although equity markets are becoming more expensive, such a strategy remains a good way for investors to stay invested in equities with reduced volatility,” he said.
BoS’ Cheo also likes long-short strategies. “Long-short makes sense for us because we think that markets are going sideways in the next few months.”
With event-driven strategies, global M&A offers opportunities as interest rates globally are still low and corporate balance sheets maintain high cash levels, Tellier said.
This year, both long-short equity and event-driven strategies were among the best performing strategies and have so far returned around 6%, according to data from Evestment. For the full-year 2016, event-driven strategies were the second best-performing among hedge fund approaches.
Hedge fund performance
Source: Evestment (last 3 months and YTD performance ending August)
Cheo noted that BoS doesn’t have a particular view on which hedge fund strategy can do better, but advises clients to go through a credible manager that allocates to different hedge funds − a fund of hedge funds.
“Hedge funds are a huge universe, so you need a good asset manager to help select the best funds. You then get exposure to different strategies, but with the best hedge fund manager in each strategy.”
BNPP Wealth clients prefer big name hedge fund managers and funds with exclusive or restricted access.
The main considerations when choosing hedge funds include track record, stability of the investment team, manager’s expertise and the fund’s turnover, he said.
Also important are the fund’s behaviour in adverse market conditions and the size and consistency in performance through market cycles.
Tellier noted that in terms of risks, investors should be aware if a strategy is highly correlated to equities. “Such strategies would suffer, albeit less than long-only funds.”
PE and real estate funds
For private equity, Tellier favours European mid-market buyout funds, which tend to have lower valuations compared to their US counterparts.
In real estate, he likes Asian real estate, which is opportunistic in nature. “The current economic and political environment in selected countries will create opportunities for sectors such as retail, logistics and offices in very specific and selected geographies,” he said.
Tellier noted that investors should accept that both PE and real estate are illiquid as they come with a premium in terms of returns and that the transparency of these funds can only be ascertained by a stringent due diligence process when selecting a manager.
“Nevertheless, in our experience, the biggest risk remains the macro-economic conditions during the course of the fund, which will impact the entry and exit of investments in the asset class.”
Commenting on private equity, BoS’ Cheo said that investors need more education about the asset class.
“They have to interpret private equity as part of their asset allocation, but because most of our customers are entrepreneurs and businessmen, they see private equity as buying into a business [as opposed to a portfolio diversifier].
“There is a tendency for them to get carried away and not interpret PE in the context of the portfolio,” he said.
