Having considered, over my last two articles, the fundamentals of investment and how we seek to differentiate our approach, I am now going to look in some more detail at some of the less conventional areas of investment, beginning this month with “alternative assets”.
Periods of volatility in global equity markets are typical. Volatility is often driven by external factors such as economic growth, inflation, interest rate and commodity price fluctuations, to name a few, and are outside of the control of the investment management community.
During such times, many investors will seek alternative asset classes to complement their portfolios. For private investors, this has historically meant investing in property, fixed income and cash; however, access to more diversified assets is possible.
Why seek to diversify?
Diversification across asset classes is recognised as a way to reduce risk. Professional investors have, for a long time, recognised the opportunities to diversify their investments, not only by using the traditional asset classes but also considering assets not easily invested in by the private investor.
Gold is a particularly good example where professional investors, in particular traders, have long regarded it as an alternative investment in times of
For many, as a tangible asset, it offers the option of capital preservation whilst retaining the potential for growth. But gold is just one asset that can be considered as alternative with many others also now available.
What are ‘alternative assets’?
Alternative assets are investments that may offer a relatively low correlation to equity markets, i.e. their source of performance may not be closely linked to those of traditional equity markets.
Assets such as commodities, debt, infrastructure, property and private equity can all be considered as alternative investments but have not always been accessible to private investors.
Alternative asset classes can offer differing levels of risk, and may react differently to external factors. By combining a variety of asset classes with differing growth cycles, the overall volatility of a portfolio can be reduced whilst maintaining the potential for long-term growth.
What are commodities?
Commodities typically describe physical substances such as food, metal or fuel which are bought or sold in their “raw” form. For example, the underlying commodity behind breakfast cereals would be wheat or other types of grain, which are physically traded before being turned into food by producers. Commodities can broadly be split into five categories:
1. Agricultural or Softs describe grain, food and fibre commodities like coffee, corn, cotton, maize, soya beans, sugar and wheat. Prices are very much driven by supply and demand and can be influenced by other factors such as currency movements – the majority of commodities are traded in US dollars.
2. Base Metals describe industrial metals such as aluminium, copper, lead, nickel, tin and zinc. These are key components in supporting global growth, in particular the construction and manufacturing industries.
3. Meat and Lifestock describes live cattle, lean hogs, pork bellies and feeder cattle. As globalisation boosts the incomes of workers in developing nations, so the demand for more expensive meat diets increases. At the same time, more efficient ways of rearing livestock are constantly being researched, which may increase supply.
4. Precious Metals are alternative assets such as gold, platinum, palladium and silver. The price of these assets can fluctuate quite dramatically and often in inverse relation to equity markets.
5. Other commodities like timber and water can also be classed as alternative assets although, unlike most other commodities, are not traded on a stock exchange. Access to these assets can be obtained via Exchange Traded Funds (ETFs) which invest in shares in companies where business activities are closely associated with the commodity.
Shares in forestry management companies, for example, provide exposure to timber. As society becomes more environmentally conscious, the importance of renewable materials and commodities increases.
Is energy a commodity?
Energy is used to describe crude oil or derived commodities such as natural gas and heating oil. Uranium is also classed as an energy commodity. Prices are usually driven by scarcity of supply, geo-political unrest, dollar weakness and global economic growth.
How are commodities traded?
Most commodities are traded on exchanges. For example, metals are traded on the London Metal Exchange (LME) but, for the private investor, ETFs now make this type of asset more accessible.
What is meant by infrastructure?
Infrastructure is a broad term to describe assets and services that underpin an economy, such as power supply, roads, water supply, waste, flood management, etc.
In the past these assets have typically been owned and managed by central or local government but, increasingly, they are attracting institutional and private investment, both domestic and foreign.
What are REITs?
Property or real estate has historically been perceived as an “alternative asset” to equities for UK investors. Until recently, investment in bricks and mortar had been seen as an inflation-beating safe haven to the more volatile equity markets.
Circumstances have changed, but investors are no longer limited to domestic real estate investment with wider choice following the introduction of REIT (Real Estate Investment Trust) legislation.
In much the same way as unit trusts allow private investors to invest in equities on a pooled basis, a REIT is a company that owns or manages commercial or residential property on behalf of its shareholders. UK REITs came into effect in January 2007.
What forms of debt are considered an alternative asset?
- Developed Sovereign Debt = a bond issued by a national government but denominated in a foreign currency. They are usually issued by countries with unstable economies susceptible to volatile exchange rates or inflation and have a higher default risk than most government issued debt.
- Emerging Market Debt = a bond issued by less developed countries as sovereign or government debt but does include some emerging market corporate debt and, unsurprisingly, these bonds tend to be sub-investment grade.
- For further information or to discuss any aspect of financial planning, contact the author, a founder member of The Ellis McComb Partnership, 3 Mortimer Street, Birkenhead, Wirral, CH41 5EU; telephone 0151 650 6520, e-mail firstname.lastname@example.org; website www.sjpp.co.uk/ellismccomb. The Ellis McComb Partnership is an appointed representative of St James’s Place Wealth Management plc.