Alternatives swing back into style

We have known for some time that wealth managers have been revaluating their asset allocation models to cope with the financial crisis and the subsequent market swings. But as the market comes to terms with instability as the only constant, there are a few noticeable trends emerging.

Scorpio Partnership recently concluded research for our semi-annual Asset Allocator report. This aims to build a dynamic picture of asset allocation trends as they are conceived and implemented by wealth management firms for their clients. The institutions included have combined assets under management of around $5,700bn (€3,940bn), some 33 per cent of the global high net worth individual (HNW) wealth managed by private banks.

The results show a couple of strong trends. Firstly, among the traditional asset classes, fixed income and cash are falling out of vogue, whereas equity allocations are on the rise as wealth managers seek inflation-beating returns. Forty per cent indicate they will increase their equity allocations in the next 12 months, even in their most conservative portfolios.

However, it is in the alternative asset classes that the most significant shifts can be seen. A whopping 84 per cent of the wealth managers surveyed are looking to increase allocations to the Asia Pacific markets this year. A further 33 per cent are looking to boost their allocations to both Latin America and the Middle East and North Africa.

The level of confidence in hedge funds, private equity, real estate and commodities is also on the rise, with investment in the core alternative asset classes back up to pre-crisis levels. The obvious questions centre on whether the shift to alternatives is a grab for returns in a low-yielding environment, or is something more meaningful going on?

One clue to the answer lies in the changing perception of risks in the alternative assets space. When asked to rate the risk/return profile of different alternative asset classes on a 1-10 scale, the results point to a significant reassessment of risk generally that appears to be taking place across the wealth management industry. Many of the respondents classified hedge funds as low risk/low return and private equity at the other end of the risk spectrum.

This low return classification for hedge funds would have seemed an anathema only a few years ago, as probably would such a swathing shift to frontier markets. But then how the world has changed. In fact, the research points to hedge funds as a defensive asset class of choice in the new market reality, with private equity as a driver for those much needed returns.

In fact, 50 per cent of the investment professionals who took part expect to increase their allocation towards private equity in the future. At the very least, these results suggest that the definition of a “safe asset” has undergone radical revision and wealth managers are looking to specialist fund managers to help manage risk more precisely.

It is strange to think that two years ago, if one had suggested that complex products would become the solution to our investment woes it would have been hardly credible, but then, these are unusual times.

Cath Tillotson is managing partner at wealth management think-tank Scorpio Partnership