Unquoted assets at forefront of renewed interest in alternatives

Despite the bitter memories of many private investors, marooned in illiquid positions soon after the financial crisis of 2008, wealthy banking clients are once again edging up their allocations to alternative portfolios.

“Ultra-high net worth clients are happy with illiquidity, as they own businesses and are able to think strategically,” says Simon Smiles, chief investment officer for the wealthiest client segment at UBS Wealth Management. “They are now taking this business thinking across into their investment portfolio.”

The large cash balances currently available to private banking clients means they are ready to allocate to attractive alternative assets, once they feel the time is right, favouring long-term investment into private markets rather than shorter-term tinkering with quoted stocks, believes Mr Smiles. Alternative themes favoured by UBS clients include real estate, mezzanine debt, asset-backed securities, global credit opportunities and other “semi-liquid, non-mainstream asset classes”.

Mr Smiles contrasts the 2008 situation with that of today, saying they are starkly different. In those days, there was a huge allocation, approaching 30 per cent to alternatives among some groups of clients. Today, there is less than 2 per cent penetration of private markets.

“The risk aversion which followed the 2008 crisis is still here with us,” says Mr Smiles. “We need to break through those barriers. Cash balances are much bigger than pre-crisis and clients are not currently enjoying the benefits of diversification.”

Data Mining

Private banks are increasingly analysing the vast rafts of client data they hold to improve diversification of asset holdings. 

“We are now able to meet client needs that they would not have necessarily expressed spontaneously, through analysing predictive behaviours,” says Vincent Lecomte, CEO of BNP Paribas Wealth Management. He uses this technique to identify, in particular, clients who may be interested in private equity investments, but have not necessarily raised their heads above the parapet.

The French bank employs an internal team, which selects private equity investments and structures them into a fund for private clients, working closely with a number of providers.

Investments into real estate are channelled both through funds and direct opportunities. While opportunities in Germany and France have proved popular, the UK’s property market has been particularly interesting due to the weakness of sterling since the Brexit referendum, offering a substantial discount to many foreign buyers. Middle Eastern and Asian investors have been particularly active in this market.

“Some clients have made some very good investments in the UK since Brexit,” says Mr Lecomte. “These are long-term investors taking advantage of both currency and price effects.”

This trend to alternative allocations is expected to be long-term, rather than a flash in the pan, with banks willing to lend in order to take advantage of a greater opportunity set. 

“Private equity is part of this diversification, as is credit. The bank has a robust balance sheet and is willing to lend. During the last six to nine months, we see clients exposed to more leverage, though still in a controlled manner. They remain cautious, but are less risk averse than a few months ago,” says Mr Lecomte.

While Banque Syz in Geneva reports some renewed interest in hedge funds, allocations are typically down to around 8 per cent, well below the 30 per cent peak in 2008. Today, there is much more activity in private equity and real estate.

“During the early 2000s, there was almost a free lunch in hedge funds,” recalls the bank’s CEO, Eric Syz, who has previously described how his clients were selling healthy businesses earning 8 per cent annually and pumping the assets into hedge funds to double their returns. 

“Everybody piled in and there was a lot of confusion about how returns are created. This was leveraged beta, not real alpha and when the crisis came, leveraged beta returns were hit very hard. People invested for all the wrong reasons in hedge funds and got hit.”

Déjà vu?

There seems to be an element of familiarity to today’s hype of the private equity story by many private banks, but all insist that this alternative trend is somehow a more wholesome and longstanding one. All made similar claims about hedge funds before the 2008 crisis, calling them a legitimate and necessary diversifier, according to now discredited ‘modern’ portfolio theory.

Typically, private bankers will talk up the transparency of investing in real companies, rather than the black boxes of yesterday’s hedge funds world. “A lot of clients feel that with private equity, they have an investment which they can understand, a real portfolio, not just a collection of immovable stocks which they know nothing about,” says Mr Syz.

Whereas his bank once held annual events for clients promoting the concept of hedge funds, introducing many new managers to the invited audiences of international clients and advisers, today the subject of these summits has switched to private equity, with a similar mix of appearances from leading providers and debate on economic and geopolitical issues.

“We are taking this very seriously,” confirms Mr Syz. Mirabaud, another Geneva stalwart, has also launched a private equity offering, with portfolios consisting of “heritage investments”, linked to unlisted European companies famed for the quality of food, designer goods and clothing. 

Lessons learned

The story is similar at UBP, just along the lakeside Rue du Rhône from Syz. “Hedge funds were the big success story of UBP before 2007 and we still have a strong capacity in that area,” says Michel Longhini, the bank’s head of private banking. But things turned sour when clients found they had collective exposures of $1bn to strategies managed by New York fraudster Bernie Madoff. The bank managed to rescue its reputation by putting aside $500m to resolve client claims. 

“The Madoff scandal brought everybody to a much more robust due diligence process, creating a new standard, but it is a problem of the past,” says Mr Longhini.

Operational due diligence in alternatives was totally overhauled as a result and private equity has become the new ‘de rigueur’ product for wealthy families, with banks such as UBP happy to structure products offering access to traditional funds from heavyweights like KKR and Carlyle. “This has become far more accessible via private banks,” says Mr Longhini. “We all started to offer this kind of access on a selective basis 10 years ago. But it has come back, as performance and yield from traditional investments has been disappointing.”

The latest development at UBP has seen clients increasingly steered into direct investments in real assets, the next step on from traditional private equity. Single investments are made into areas such as student housing in large cities, and aircraft, both attracting a higher yield than stocks and bonds.

“Ultra-high net worth, professional investors are looking to these types of assets for a yield which you cannot see in today’s market environment,” says Mr Longhini, while these same investors are looking at hedge funds only “very selectively”, he says. 

“The level of interest in hedge funds has gone down sharply,” with funds of funds failing to perform in the current environment. “Hedge funds need volatility and that is historically low,” warns Mr Longhini. “Many traditional hedge funds have disappeared or lost their attractiveness. Nowadays we are focused on a limited number of very good funds.”