Solving the alternatives riddle – InvestmentNews 11-17-13

Salient to Investors:

There are more than 400 liquid alternative, hedge-fund-like strategies offered in a mutual fund wrapper, up from a few dozen prior to the financial crisis.

Many observers think it unlikely that equity returns will continue to be as robust as the last 5 years, while bonds face the well-known risk of rising interest rates.

Christine Johnson at Deustche Asset & Wealth Mgmt said alternatives are not going to keep up with a bull market and while they reduce volatility, they are not a yield replacement. She likes long/short equity for aggressive clients.

The Morningstar MSCI Composite AW Hedge Fund Index rose less than 5% through September 30, 2013 versus almost 20% for the S&P 500.

Nadia Papagiannis at Morningstar said alternatives should be used to reduce risk and volatility and not to chase returns, so are more suitable for more risk-averse investors, while younger investors who don’t need to worry about liquidity could benefit from the more illiquid strategies, such as private equity or private real estate, because of their long investment horizons.

She prefers strategies that are hedging volatility, such as long/short equity funds that buy puts to protect the downside. Papagiannis said that nontraditional bond funds tend to take on a lot of credit risk and are therefore vulnerable if the stock market falls.

Philip Roberts at Round Table Services said funds of funds give you immediate diversification. Morningstar said the average expense ratio of such funds is 1.85%. Roberts prefers merger arbitrage strategies.

Glenn Myers at The MDE Group said we are at the end of 30 years of falling interest rates, so we need creative ways to control volatility and get returns without relying on a large allocation to fixed income.

Natixis Global Asset Mgmt found that only 25% of advisers said they regularly use alternative investments, while 75% don’t primarily due to a lack of understanding.

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BofA Cuts Jobs as Mortgage Slump Traps JPMorgan, Wells Fargo – Bloomberg 09-10-13

Salient to Investors:

Mortgage lenders are warning that the drop in demand for refinancing may be steeper than expected as surging interest rates crimp demand and cast doubt on how much the housing market will improve.

Guy Cecala at Inside Mortgage Finance said yesterday’s Wells Fargo comments and Bank of America’s job cuts show clearly doesn’t bode well.

Nancy Bush at NAB Research said we are pretty much through the refinancing boom, and don’t know yet what the purchase business will look like.

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Property Crushes Hedge Funds in Alternative Markets – Bloomberg 07-10-13

Salient to Investors:

Hamilton “Tony” James of Blackstone Group said stocks were a fool’s game compared with alternative investments. and investing in alternatives makes sense even when they underperform. James said the return from these idiosyncratic investments are very uncorrelated to the broader markets, so portfolio volatility falls.

Hedge funds have been disappointing investors for years. Virtually every alternative investment category crashed in the financial meltdown of 2007 to 2009, none more severely than property, with housing and commercial real estate prices falling as much as 40 percent.

Bloomberg Markets says over the past three years to March 28, 2013:

  • REITs gained more than any other alternative category: large-cap REITs returned 17.3 percent annualized versus private equity which returned 15.2 percent.
  • The best-performing unconventional investments ranged from corn, 33.8 percent annualized, and silver futures, 20.5 percent annualized, to a Chateau Pavie Bordeaux and a 1957 Ferrari 250 Testarossa.
  • Among the worst-performing alternatives were hedge funds, 3.3 percent, and funds of hedge funds, which lost money.
  • The S&P 500 returned 12.7 percent annualized.
  • For investors in real estate and REITs, valuations fell further and faster than other assets and have in the past three years jumped higher than the S&P 500.
  • REITs that invest in shopping malls boasted the best performance with an annualized return of 25.3 percent. REITs that invest in self-storage units, industrial plants, health care, retail and Asian real estate produced 20 percent-plus gains.
  • Hedge-funds invested in mortgage-backed securities gained more than 20 percent annualized
  • Overall commodities returned 3.1 percent, but corn futures returned 33.8 percent.
  • Classic cars and coins gained more than 15 percent annualized.
  • The poor performance of macro funds has been a reason for hedge funds’ overall mediocre 3.3 percent return.

  • Fund-of-funds have lost an annualized 3.8 percent over 3 years, while more than 600 funds of funds, or 25 percent of the total, have gone out of business since 2007.

Bob Rice at Tangent Capital Partners said things that are way down are going to come back, while central banks have given people a prevalence of cheap money to borrow and get back into alternatives such as real estate. Rice says you are starting to see more and more REITs that are borrowing to pay their dividends; a yellow flag to those chasing the asset class right now. Rice says private equity offerings to small investors is the next wave of alternative offerings.

REITs are a growing asset class in Europe and Asia.

Brian Hargrave at ZAIS Financial said the single biggest advantage of REITs is that they’re required to distribute at least 90 percent of their taxable earnings to shareholders as dividends.

The real estate moguls whose heavy borrowing helped fuel the 2008 financial crisis are back at it, taking advantage of Fed-driven low interest rates to amplify their returns through leverage.

David Fann at TorreyCove Capital Partners said real estate has been a huge beneficiary of QE so when central banks finally start raising interest rates, that could quickly end the new property boom and curtail the longer-term appeal of real estate investing. Fann said many of the large private equity deals that were undertaken during the boom period got salvaged because of quantitative easing.

Carl Friedrich at Piermont Wealth Mgmt said hedge funds in aggregate will more and more like the broader market as their asset base continues to grow.

Paul Ashworth at Capital Economics says corn and other agricultural commodities are a bubble which will burst in the next few years – low interest rates to buy farmland and higher yields for corn per acre.

Private equity, aka leveraged buyouts, has benefited greatly from the post-crisis low-interest-rate environment.

Preqin says global private-equity holdings surpassed $3 trillion of assets under management in 2011 for the first time and have continued to grow. KKR owns companies that employ 980,000 people. Blackstone’s more than 730,000, and Apollo’s 370,000.

David John at Brookings says if private equity offerings to small investors start to take hold, there needs to be either licensing, a seal of approval or some level of higher oversight so people don’t find that they are investing in unsuitable for their stage of life.

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Roubini Sees Gold Falling to $1,000 by 2015 on Global Recovery – Bloomberg 06-03-13

Salient to Investors:

Nouriel Roubini at NYU says gold may fall toward $1,000 by 2015 as the economic recovery curbs demand for bullion, there is a lack of inflation, and other assets such as equities offer better returns. Roubini said investors should have a very modest share of gold and other real assets in their portfolios as a hedge against extreme tail risks, which are lower today than at the peak of the global financial crisis.

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Diamond Brings Record $21.5 Million, Beatles Art $87,720 – Bloomberg 11-13-12

Salient to Investors:

The Archduke Joseph Diamond sold for $282,545 per carat, a record for a colorless stone.

Geoffrey Munn at Wartski said the best diamonds have become extraordinarily valuable – there’s a scramble to buy jewels as a hedge. Munn said colored diamonds, which have set the highest auction prices, are rarer and more popular.

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The Ethical Investor: Wall Street Ripoff #10 – Recommending Products With Enormous Sales Commissions – Huffington Post 11-09-12

Salient to Investors:

John R. Talbott writes:
Total costs of 2% per year in a fund earning a 3 percent real return is tantamount to giving Wall Street two-thirds of the profits. ETF’s that cost a half a percent to 1 percent per year can end up costing as much as one-third of total profits over time.

More complex products can cost investors sales commissions of 5 to 12 percent. Usually the more complex and complicated a financial product is, the higher its cost to investors. Insurance companies have excelled at complex products.

Most insurance products, especially those that pretend to be investment products, have very high costs. Variable annuities pretend to be a combination of investment products with an insurance guarantee but cost much more than simply buying insurance and investing in the stock market. Sales commissions exceed 5 percent, and annual costs are greater than even a mutual fund – you pay the insurance company and the fund administrator.

Only buy insurance for events that are so unpredictable and destabilizing that your family could not get by without it. Avoid whole life or cash value policies, and universal life or variable life policies. Buy term insurance only for the shortest time period you absolutely need it.

Reverse mortgages are enormously complex and combine the worst attributes of mortgage products, insurance and annuities. Many reverse mortgage companies have come under scrutiny recently by regulators who find their sales practices and operations fraudulent and deceptive.

The “guaranteed” return is a myth since when times get tough, the institutions making it will face insolvency. And there is little value in guaranteeing a 4 percent annual yield in dollars if inflation returns to 10% per year.

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Public-Pensions Gain 4.67% in Third Quarter on Bonds – Bloomberg 11-06-12

Salient to Investors:

Wilshire Associates said US public pensions ended Q3 with a median gain of 4.67 percent as bond managers bought riskier debt and fixed-income securities with longer maturities. The median public pension was 55.5 percent in stocks, 25.7 percent in bonds, almost 3.7 percent in real estate, and 1.9 percent in alternative investments such as LBOs or distressed-bond funds, 2.5 percent in cash.

Robert Waid at Wilshire said the results give a strong message to stay the course and look to the long-term. Waid said fixed-income benchmarks, such as the Barclays index, don’t accurately reflect available opportunities because they’re heavily weighted toward US or foreign government bonds.

Junk bonds returned 4.6 percent in Q3.  High-yield company bonds have gained 13.3 percent in 2012 versus 10.4 percent for the total returns on a broad index of corporate debt.

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Million-Dollar Traders Replaced With Machines Amid Cuts – Bloomberg 11-06-12

Salient to Investors:

Credit-derivatives traders are being replaced by machines as automated trading makes humans too expensive.

Michael Karp at Options Group said that as late as 2005, managing directors on credit-derivative trading desks were being paid an average $250,000 in salaries and $1.75 million in bonuses.

Peter Tchir at TF Market Advisors said building an algorithm may cost a few hundred thousand dollars, and their increasing popularity is an example of how credit markets are becoming more like stocks.

Citigroup said the balance of debt past due tied to skyscrapers, shopping malls and hotels fell to the lowest since April 2010.

Sales of commercial-mortgage backed securities are surging as investors look for higher yields even as slow economic growth threatens to hold down rent and occupancy rates.

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State Funds Focus on Alternative Assets, Ex-KIC Official Says – Bloomberg 10-18-12

Salient to Investors:

Investors are growing wary of publicly traded securities as interest rate cuts at central banks helped inject liquidity into markets, bolstering bonds and stocks.

Scott Kalb at KLTI Advisors said:

  • Sovereign wealth funds are increasing their allocations to alternatives
  • Institutional investors are focusing on hedge funds and private equity, with real estate and infrastructure being the preferred asset classes.
  • Real estate is attractive because it is bottoming in the US, infrastructure is low, and there is a lot of demand.
  • Sovereign wealth funds, being long-term investors, will keep investing in emerging market assets as the prospects for those economies remain strong.
  • When investing in emerging economies, the portfolio should comprise all major asset classes – private equity, real estate, infrastructure, debt, equity and commodities.

Joyce Shapiro at Franklin Templeton Investments said institutional investors may double the proportion of infrastructure investments in their portfolios within 5 to 10 years.

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Japan Teachers Fund to Start REIT and Hedge Fund Investments – Bloomberg 09-23-12

Salient to Investors:

Toru Higuchi at Japan’s Teachers’ Mutual Aid Co- operative Society will start investing in REITs and hedge funds.

Japan’s has the world’s second-largest retirement pool, after the U.S., with  only 6 percent in alternative assets versus 25 percent in the U.S. and 24 percent in Australia.

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