Daniel Root:
Hello. Welcome and thank you for taking the time to join us. I’m Daniel Root here from the PFS, and I’m your host for this session. Today we’re joined by David Cooke and Nick Heath from Saltus, who are delivering a session on Beyond Stocks and Bonds. What Are the Alternative Investments? Shortly, David and Nick will be speaking for around 40 minutes, after which we’ll have time for your questions. Please put your questions in the Q&A box. David and Nick will speaking for 40 minutes. I’ll hand it over to the speakers.
Nick Heath:
Okay, thank you, Daniel. Good morning everybody. Great to see so many of you on the call. We can see by how many people have registered, which is kind of north of 150, that the topic that we’re going to cover this morning has very much struck a chord with the audience. And let’s just touch on why we’re covering this topic in particular. Many of you on this call obviously use portfolios with your clients, or will be researching portfolios with your clients. And it’s fair to say the traditional approach to portfolio construction is very much through the lens of stocks and bonds, that classic 60/40 portfolio. And often, when people talk about diversifying away from stocks and bonds, it can be through the lens of perhaps using some property funds. But what we’re going to focus on today is a third stool, if you like, to portfolio construction, and that’s the use of alternative asset classes.
Now, alternative asset classes, both within our peer group, and obviously for clients, can often kind of be misunderstood, and they can offer screen high-risk. So in the next 30 minutes or so, David and I are hopefully going to get you to the end of the call, where you have a better understanding what they are. And ultimately, why you might consider using them within portfolios. And then finally, what would a portfolio look like in practise? And before we get into that, I think it’s probably worth just giving you some context to who Saltus are and why we have a particular view on alternative asset classes within portfolio construction. And we’re in our 20th year as a firm, and the genesis of Saltus, the way that we came about, is two co-founders, both working in private equity and for Goldman Sachs.
And what they were doing there is running portfolios for university endowment funds, ultra-high net worth clients. And what they observed is that the portfolio tools that were being used for that particular type of client were more sophisticated than was readily available in the mass retail market. So their call to arms was to democratise that and make it available to more people in UK financial services. And that’s what we’ve been doing successfully for the last 20 years. So we are now an investment management business, but we also have around 60 financial planners in our business, and we look after around 10 billion of client assets. So we’ve got around 30 minutes worth of slide content. Please do ask questions as we go along in the Q&A box. And we’ve also got three polls, so we’re going to be inviting you for your answers and commentary to help this flow along. But David, I’m going to hand over to you, so you can set the scene around the alternative universe and its characteristics.
David Cooke:
Thank you, Nick. And hello everybody, thank you for turning up this morning. I’ll just say a couple of things in advance, I’ve got this grand CIO title and partner as well, but I’m a portfolio manager, and our job, the team here, is to make outperforming portfolios for your clients and that’s it. So the alternatives investment universe only exists to us as a very pragmatic firm, as something that might be able to help us do that, and that’s the only reason we look at it. So before we get into it, let’s try and get our heads around what it actually is. So this is the Saltus definition of alternative assets. Others are available, but I think this is the simplest one. It’s a residual. Alternative assets are what’s left after you subtract the traditional equities, bonds, and cash from the investment universe.
And cash, for most of you and most clients in the UK, is X’d out already. It’s a tiny part of a portfolio. So it’s mainly the traditional global stock and global bond markets, which tend to be the securities of larger companies that are traded on stock exchange or traded publicly in some fashion. If we look beyond that, everything else, it’s a catch-all term. I can think of at least 11 categories, and within these categories, sub-categories. So we’re actually talking about dozens of things, which is why it’s kind of impossible to get a more precise definition other than this residual. So it’s a pretty wide universe to start with by definition. And if we think about the characteristics of alternative assets, I have, through talking with advisors and some clients over the years, I would say that there’s a little bit of a negative vibe associated with the alternative assets universe.
And I think it’s because of the following characteristics. They’re often described as being complex. Strategies in there which are wordy and quite mathematical when you get behind the underlying logic. And it’s just hard work to try and get at what people are trying to do. I’m often told that they’re illiquid, that most of our universe seems to have gravitated towards daily dealing, vanilla strategies is a universal good thing, and illiquidity is a bad thing. That may not necessarily be true, but illiquidity is certainly a feature of why people are a little bit hesitant looking at the universe. There’s leverage or borrowing money to amplify your footprint. Leverage is not necessarily a bad thing, as anybody that owns a house or a flat in the UK will tell you, but if it goes wrong, it can amplify the mistakes. And if you’re illiquid at the same time, then you can’t get out of them. And then if they’re complex, then you find it really quite difficult to explain yourself or understand why things have gone wrong.
Other reasons I’ve heard as characteristics of the universe, I think this one’s a bit old school. In the olden days when, certainly in the UK, when funds were often sold on a standalone basis as products, there was scope to mis-sell opaque, illiquid, and leveraged investment strategies without really understanding what they were. But I do think that’s something in the past, because anything that we do as a manager or any of the investments that we use are regulated, heavily regulated.
Opaque means that sometimes, particularly in the private world, you don’t have to do the disclosure that you have to do in the public world, and you don’t have to do it as often, thereby leaving investors wondering what on earth is going on under the bonnet. And finally, the classic expense issue, because we live in a very cost-sensitive industry, and if you have opaque information, it gets hard to work out the difference between value and cost. So if you take all these together, I think that’s kind of been the major reasons behind widespread adoption of alternatives in a private client portfolio in the UK. And I think we’re going to do our first poll now. So if we were to… I think Nick’s got it on the next page.
Nick Heath:
Yeah, if we kick on. So David has obviously mentioned that the factors that people often cite as barriers to using alternatives. And I guess what we would like to know from you is, which of these is your biggest barrier or perceived barrier? So if you could select one, that would be fantastic. We’ll leave it on the screen for the next 30 seconds or so. Here we go. People warming to the task.
David Cooke:
Yeah. I don’t know if you can see how many are clicking answers, but we can.
Nick Heath:
We’re approaching half. So yeah, what would be the biggest characteristic deal breaker when you’re thinking of alternatives? 10 seconds and then we’ll move on. Let’s get to half. Great. Okay, we’re going to close the poll in three, two, one. Okay, thank you very much, those of you that submitted your thinking there. David, should we just pause and reflect?
David Cooke:
Yeah. We had no idea how this was going to end, and my best guess was that it’s going to be a mix, and that looks like a mix to me with complexity, illiquidity, opaqueness, and then this lingering sense that things are lightly regulated and then quite easy to get in trouble. But it looks like it’s an agglomeration of things. Okay. Okay.
Nick Heath:
Thank you.
David Cooke:
So should I take the next one?
Nick Heath:
Yeah, go for it.
David Cooke:
Let’s start demystifying some of the bigger asset classes, and then let’s start with some simple observations about complexity. I would challenge any of you or any of your clients not to understand what oil is or gold, and between all of us, including our clients, I think we know more about property than we know about anything else, particularly in the UK. And I’m pretty sure that we all can understand that IKEA may be a private company, and Marks & Spencer may be a public company, but the differences in essence between the two, there aren’t really any. So it doesn’t take a lot to just point out that if you get behind the word, a lot of what we’re talking about is instinctively and immediately understandable as an investment. And on the liquidity point, without trying too hard, I looked up the IA sectors and the UK investment trust sector, and looked at things that could be reasonably called alternatives.
And without trying too hard, I could find over 500 different funds or trusts. And you can go beyond those two universes into the OEIC market as well outside of the IA sector. So if our minimum is that you can get 500 readily available options to have a look at, that kind of… And this isn’t a daily dealing universe, importantly, that kind of is a… Yes, liquidity is a point, but no, it doesn’t have to be a real risk. Leverage, as anybody, as you said, has bought a house or a flat, is not necessarily a bad thing, it lets you get on with your life. But many of these strategies are not leveraged, is the first point. And secondly, they can be leveraged or use borrowed money in a non-scary way. I will go into that a little bit more detailed, but a lot of the leverage point is there’s images of to fly by night.
Probably young men kicked out of a large American investment bank, punting around with borrowed money on dangerous things, and therefore getting in trouble. That’s like a caricature of what was, that’s not the leverage universe as is. As you said, onshore OEICs, investment trusts, there’s plenty of them. And any fund you access will have independent authorised corporate directors who are all over risks. And finally, because of the regulated nature, and particularly things like the daily dealing universe in the UK, you get regular clear reporting on what’s going on. The companies do road shows, has value for money assessments, and the cost disclosures are pretty clear as well. So you can actually work out if it’s worthwhile paying to get the characteristics of the investment. So just lightly touching on why some of the myths surrounding characteristics are quite easy to dispel. Oh yeah, doing this one. Poll number two. A bit of fun.
Nick Heath:
Yeah, we’re quickly following up with poll number two. So there are three polls in total, but we’re getting you up and running early. So when we think about the investable global universe, what do we think the total available in dollars, in the investable global universe? And we’re going to help you here and give you a clue, it’s in trillions. So what is the total in trillions of dollars of the investable global universe? If you could pop your answer in the Q&A chat box, and I’ll give you 30 seconds, and then we’ll see where we’re at at the end. Wonder if this is working actually because I’m not seeing anything come through.
David Cooke:
Shall we relieve this suspense by clicking onto the next slide then?
Nick Heath:
Yeah, I think so, let’s just move on from this one.
David Cooke:
Again, this is our definition with a lot of help from JP Morgan. So what we’ve taken here is the… I’m talking about the financial instruments that give us access to underlying asset class. I’m not necessarily talking about the asset class in aggregate. So all the property in the world is worth more than what I say it is here, but not all that property is accessible via a financial instrument, be that a mortgage or a real estate investment trust. And for the commodity markets, I’ve taken the futures market positions just to give us a proxy. It’s about $222 trillion worth of an investment universe, and that is just about twice the size of the global economy at the minute, I think it’s 114 trillion is the estimate for 2025. And the asset classes are dominated by size by the traditional equity markets, which are getting on towards 50%, and bond markets, government bonds, corporate bonds, which is another 35%.
So you can see why traditional style portfolios dominate, because that is 80% of the available universe by size, but you could also flip it on its head and say that somewhere between 15 and 20% of the investable universe is in alternatives. And if we drill down a little bit more on that, we’re talking $35 trillion worth of assets that is the swimming pool at the moment and growing quite quickly. Most of this is dominated by property and the private markets, whether you’re investing in the equity or the debt securities of private companies. But there’s also an awful lot of things outside of this that you will have heard of that you might be surprised by just how big in liquid the markets are. For example, digital, the rapidly emerging digital market. Hedge funds have been something that people have heard of for a while. Maybe slightly surprising just how little the commodity market features in client portfolios, and as something that people really in the financial universe want to get access to.
But I would say that if we start with a giant number like this, a couple of things stand out. First off, there’s a lot of subcategories within that, but the main ones, again, would be in the private space and in real estate. So that gives us a flavour of the universe. Let’s get to why bother, the $60,000 question. There’s one strategic region, and I’ve spent much of my career trying to find a chart like this. This is what portfolio managers do. You might think that we are in the business of generating returns. Actually, our primary duty is to control risks. We can’t make a stock market go up 10%, but we should be able to control the risks.
And what we’re trying to do is control the downside risk, because this little graph shows that if you start taking hits to your client capital, and the numbers start getting bigger, let’s say the 20 to 30% drawdowns, then you’ve got to make an awful lot of money to get back to flat again. This is some pretty simple primary school mathematics, and it’s basically telling you that if you fall into a big hole, investment wise, it’s really hard to get back up again. Try very hard not to fall into a big hole, and that means diversify as far as you can, Mr. portfolio manager, and thereby manage your downside risk. So this is, in our opinion, always and forever true.
Occasionally, now you get other reasons, right here, right now, this is a 10 year… Oh well, it’s going back to 1996. A graph of the correlation in the price movements between the global stock market, it’s the MSCI World Equity Index. And Bloomberg’s global aggregate total returns for the bond market. So global stocks and global bonds have a very high positive correlation at the moment, and you can see that this correlation cycles over time, and sometimes it’s negative, which means that the prices move in opposite directions, and sometimes, like now, the prices of stocks and bonds are moving in the same direction, almost one for one. And that is a tactical warning signal that there’s not a lot of diversification out there in their main asset classes. Got to be aware of this.
Nick Heath:
So David, just so I can check my own understanding here, it looks like in the post-COVID environment, as demonstrated by the green part of this chart, that correlation is on the rise, i.e. bonds and equities have been moving broadly in the same direction.
David Cooke:
Yeah. Correlation is, just use the plain English definition of correlation, it’s the degree to which two things move in tandem. If they move one for one, they move in tandem in the same kind of size, magnitude, and in the same direction. And if they move negatively, then one price is moving in the opposite direction to the other price. But it’s a diversification point. I mean, there is a degree to which the prices of the major asset classes at the moment are moving up and down together. So you might think you’ve got a diversified portfolio, but you might not have that at the moment.
Another reason is if you look at the concentration in equity market indices, this is quite a technical chart from Soc Gen, but it’s basically saying in the global stock market, let’s say 1,300 companies, if you had to replicate that index, the concentration in that index, how many companies would you need? And about now, it’s only about a hundred, whereas in the olden days you needed an awful lot more. So what it’s saying at the moment is pretty much that the equity indices are all concentrated in terms of the dominance of large companies, mainly clustered around the technology space, which in turn is clustered around this artificial intelligence theme, has been very strong for the last couple of years.
It’s kind of like you never really want to put all your money on 13 black on the roulette table. You don’t want to put all your eggs in one basket, but increasingly at this point in time, that’s the way equity markets are looking. And it’s not just the Americans, it’s globally, and you get it in Europe as well, and in Asia. Another thing that’s happening in the largest asset class at the moment is that stock markets are highly correlated with liquidity. Now, this is from one of our managers called Neuberger Berman, and it’s just looking at the correlation between the money liquidity in the American stock market and the returns. And what it’s saying is that when you’ve got a lot of money sloshing around the financial system, it tends to find its way into risk taking and push asset prices up, particularly risky ones.
And this is understandable, because after COVID, authorities through various liquidity measures, pumped an awful lot of money into the system, pump priming, to keep us alive as we tried to recover post-COVID. And that’s not necessarily a bad thing, but it is a thing. And the reason I put it up is that liquidity is cyclical, just like business cycles, interest rates, they go up and they go down. And at the moment, there’s a lot of liquidity around, and it’s having a significant effect on returns. So those are all the more tactical considerations to take in account of the more general consideration that diversification is a good thing to manage a downside risk. Alternatives might offer a way out from these slightly uncomfortable truths about the tactical world at the moment. What are taken here on the left, these are actual manager and tracker positions we have, and client portfolios, and I just put their category on the top. And I plotted how correlated they are against the world equity index, the global bond market, and the global commodity market, and then I also took the foreign exchange effect out of the world equity markets.
And what you can see is, for these categories, which half of them are pretty easy to understand, gold, and gold equities, copper, a little bit of yen, strategic bonds, strat bond sector, I’m sure everybody knows. And equity long-shorts, convertible bonds, I’m sure people understand as well or have heard of. You can see two things here. One is that there’s a bit of red, so we can get investments that, historically at least, have moved in the opposite direction to other asset classes. And that’s good because it means that these investments are doing their own thing, which is what we want. And where there is correlation, and it’s kind of hard in the past to avoid moving when you have things like COVID and US presidential policies impacting everything, everywhere, all at once. But these correlation numbers are quite small, so some of these investments might move in the same direction, in the same day, as all the other stuff, but not one for one.
So this is showing that, historically at least, there’s some ability to get lower correlations and even negative ones, and that helps us diversify the risks in the portfolio. So to summarise, the whole reason for looking at the alternative universe is entirely pragmatic. It just gives a manager an additional route to diversify the investment risk and then help manage the downsides to client capital whenever things take a turn for the worse. Currently, we’d say that the largest asset classes are quite highly correlated. They’re moving in tandem, they’re moving up at the minute, which is great, but wouldn’t be so great if they were moving down at the moment, which could happen. The equity markets are highly concentrated, so it feels like we’re putting all our bets on one big theme continuing to be right. And equity markets have also been fueled by liquidity, which is cyclical. It’s good when it’s there, not so good when it’s not there.
So when we think about a portfolio, building it and diversifying the risks, classic for manager speak, but it is tricky at this time. And I know we say that all the time, but really it is this time. So when we can see, in practise, some negative or lowly correlated investments, which are available without being too complex or expensive, then we are really tempted to use them if we can build an investment case. So that’s the universe and the reasons why one might want to have a look at them. Let’s try and take a little scoot around the characteristics of some of the bigger alternative assets. Private assets, I heard a lot about this. The reason that private assets might be interesting is that you can get access to faster growing companies, usually. That may be because they’re young, and they’re a new technology, and growing quickly, or it may be because they’re old, a good company with a bad balance sheet that’s being restructured.
But either way, they’re off the main radar scope, tend to be, by accident or design, and that gives an opportunity because there’s plenty of good companies out there, that if you can invest in their bonds or their shares, you can get some really strong upside. And investing with private assets typically gives you, us, as the investors, a high degree of influence on the outcomes, and managers who are very strongly aligned with everything going right. Against that, we’ve got the obvious risks that private assets tend to be a liquid, all the returns tend to be in the future, so this is a real test for everybody. We always talk about being long-term investors, you really have to be in private markets. It does require a bit of work, and it does require a bit of thinking once you’re in, and managing capital calls, and so on. But overall, the chances, in theory, of getting the value upside, often outweigh the risks. Let’s see if I can provide some evidence for that.
I just looked at private debt here going back to 2009, this is from Goldman Sachs, and comparing private debt markets to a comparable public debt market. So you probably have heard of the high-yield bond sector or the debt of riskier companies, that’s in purple. If we compare the total returns, going back to 2009, you can see that these three lines, whether it’s private debt and aggregate, or the distress debt, or the turnaround situations, or mezzanine, or let’s call that bridge finance, you can get super normal returns, sometimes two, three, well, multiples of equivalent public opportunities. And by the way, this high-yield debt performance is pretty darn good. This is one hell of an asset class. I mean, depending on where you look at it, but quite often this has got better returns in stock markets for much lower risk, so this is not a soft comparator. So there’s evidence that you can, if you get it right and you do your work, you can get super normal returns over the long run from private assets.
This is a chart I made myself, so apologies in advance. I was trying to explain hedge funds and how does a hedge fund do what it does? And I put the answer that’s common to them all, in small brackets at the end of it, which is leverage, which is usually all of them use borrowed money, to amplify the footprint, to give excess returns, if they get it right. So if you take a pound of capital for a typical… Let’s think of an equity long-short fund, you give them a pound, most of that money is put in short-term government debt earning interest, and let’s say 90p of that pound. And 10p is used as a deposit to borrow more money against and go and buy things, the so-called long positions. So already you can see your £1 is effectively on deposit earning cash as your base return.
I mean, obviously there’s a bit of haircut, because we’re using a chunk of that to go and borrow. But you’ve also got investment positions as well, which can be up to a pound, depending on how much leverage you can get. So this footprint is already bigger than the money that you gave them. Now, what a hedge fund can do then on the other side, as well as making its footprint larger, is start to manage the risk by selling things against these long investments, the so-called short investments. And if you have a pound of long investments, you can usually, as a typical market neutral hedge fund, sell a pound of stock against it and take the market risk out. So if you have one pound of Tesco, you can sell a pound of Sainsbury’s against it, and that will take out the UK equity market where both of them trade, because you loaned it here and you just sold it here. And all that matters is that Tesco does better than Sainsbury’s.
And if you all said it entirely, you’ve kind of hedged the entire thing. But a lot of hedge funds don’t offset the entire amount, they’re not market neutral, they’re going for higher returns, so they’ll only offset a little bit. But the point is the hedge here is a means of getting insurance against being entirely dependent on a market direction. So that’s my attempt at trying to explain all hedge fund strategies everywhere. Larger footprints and a little bit of insurance buying should equal better returns. Let’s have a look. So this is 10 years, I took the Bloomberg hedge fund indices, that’s long-short commodities distress debt, which is turnarounds of companies. Macro hedge is the George Soros type foreign exchange in interest rate trading.
So in black is the world equity market, and as you can see, it’s done rather well, whilst moving around a lot. And these are the various hedge fund indices. Now, you might be asking, so why am I bothering? And I’m not saying that these are universally correct, I’m just saying it’s qualified yes. I didn’t put on cash, which if you took UK cash over this period, is about 18%. So all of these strategies are giving you higher returns than leaving your money with a Halifax. So that’s investment case number one. It is possible, using history as a guide, to come out of cash and get a higher return. I’d also point out that this long-short index is maybe half the returns in aggregator of the global listed stock market, but it’s also half the volatility as well. So risk adjusted, a lot of these lines, when you divide by the volatility of the returns, they’re smoother than the black line, have a better risk adjusted performance. And then maybe counterintuitively, that kind of makes them better bets for the lower to medium risk client, rather than the higher one.
As you get more towards market neutral strategies, which take out the volatility in markets, then you’re more in the cash plus one, cash plus two type strategy, and that tends to be for the lower risk brands, that might be counterintuitive. But again, it’s a qualified yes if we took hedge funds in aggregate. And a final one that we’ve all got to think about now, because of the very stable GENIUS Act in the United States, is basically a regulatory framework to bring in stable coins, which are a form of cryptocurrency, albeit backed by dollars underneath, into the regulatory system. What this means is that crypto, because of this act, is now welded into the traditional money system through a regulatory framework. And that means that we’re going to have to come up with an opinion on digital assets.
So digital assets kind of like Chinese equities or gold mining shares, they are highly volatile things, which have an investment case. You may not use them very often, but you can’t ignore them, you’ve got to have a view. And I just wanted to highlight that the digital thing is now arriving for us and other managers to take a view on whether there’s an opportunity in here or not. So let’s try and wind it up with a… So we take the universe, we take the strategies, we take the characteristics, what does that mean for a client? Well, if we start with what we do, at the moment, right here, right now, this is our view topped on. We’ve got things going on that are bad. The bond markets are nervous, particularly at the longer end. You might’ve heard an awful lot about guilt selling off recently. Sentiment’s really strong, volatility is actually quite low, complacency’s out there. It’s quite hard work to find a cheap asset at the moment.
We know the government balance sheets are weak, not just ours, but also elsewhere. And we know that liquidity or cheap money is in a cycle. So these are things that stop and make you think. But against that, we also have interest rate cuts, the planet is growing, corporate and household balance sheets are pretty good, even if the governments is not so good. The oil price is low and there’s this artificial intelligence theme, which may deliver real benefits. So on balance, if we were looking at the world, we’re saying that positives outweigh the negatives, but not massively, so tread carefully. So how would you put that into a portfolio, just for a balanced investor?
Hopefully you can see this, so we’ll zoom in on the next slide. So for just a riskband three, someone taking up to two-thirds of stock market risk, at the moment, will have quite a lot of inequities, but the bulk of everything else is really in the alternatives universe. We do have bonds and cash, but these bonds are very low sensitivity to interest rate, so they’re kind of heading towards the cash end of the spectrum. So this is our call, as to if you had full freedom as to unrestricted on things like costs, what would the right answer look like now? We zoomed in on alternatives. We can see 12 different subcategories that I mentioned. We’ve got 24 individual positions. They’re a mix of active and passive. This is the pragmatism point. We don’t care if it’s active or passive, we choose whatever instrument gives us the access to the underlying investment in the most efficient way.
And you can see that there’s some household names in here and some niche names you might not have heard of. And for this particular portfolio, 70% of these investments will be in daily dealing or at-worth weekly dealing, onshore type legal wrappers. And in other models we can make that a hundred percent. But you can see that there’s… You may think 33% is quite a lot, but when you start to deconstruct it into things like, look, we’ve got a bit of copper, and some gold, and a bit more gold, beat over gold equities, that wouldn’t seem such a scary thing to do. We’ve held private equity positions for the best part of a decade. When equity markets are so strong and at their all-time highs, maybe we want people not relying on that continuing, can make money from both rising and falling markets, so-called long-short, and convertible bonds, which have been around for a very long time, but because it give you this nice ability to straddle the stock-unborn world, whilst have a little bit of optionality, so this is a practical answer.
Nick Heath:
Okay.
David Cooke:
Yep.
Nick Heath:
There’s a couple of questions that come through.
David Cooke:
Oh, great. Okay.
Nick Heath:
Which should be really good. So could you just go back to the previous slide, which was the look through of the portfolio?
David Cooke:
Yep.
Nick Heath:
So the first question from Ian, so thank you for putting that question through, Ian. What do you do to avoid the point where diversification goes too far, i.e. where the good and the bad cancel each other out, leaving you stuck in the middle?
David Cooke:
Brilliant.
Nick Heath:
That is a great question.
David Cooke:
It’s a brilliant question, because internally, right from the start, we had this thought in our heads, and we’ve even got a Saltus phrase for it, we call it grey goo. How can you not end up with something that’s just a bit disappointing and doesn’t really move? There’s a couple of things. The simplest answers are the most powerful one, is that you have an investment process and an investment team that assesses whether the ideas are working or not in real-time. And our investment committee meetings are weekly and the team chats about this stuff every day, but we will change and omit our mistakes very quickly if something looks like it’s not doing what we’ve thought, either it’s not protecting or it’s not making us any money.
The second thing is that a lot of it, at the portfolio level, is about your overall call and whether you should use up your full allocation of risk, your full risk budget, or whether you should dial it back a bit. And if we’re taking the full amounts of risk, which we’re close to at the moment, but not at the moment, then the answer to avoiding grey goo is just staying on top of the individual components and making sure they’re doing what they’re doing. Actually, coincidentally, after the last asset allocation meeting, this box on the right is being shrunk as our conviction grows in some of the strategies that are working well and not in some of the others. So for example, a practical answer would be in equity longshore hedge funds, there is a peculiar strategy, Neuberger Berman in this case, that deals in the American equity market with the amount of corporate transformations, or mergers, and the arbitrage activity takeovers and the like. And that’s a universe that is quite hot at the moment, and that opportunity side is really working.
If you just took the opposite end of the spectrum, it is more difficult if you are looking at the global equity markets and trying to pick the winners in the stocks, and then sell the losers against that. So global, like UBS, well, maybe not to single them out, but I just have, is not a strategy that’s working particularly well at the moment because it’s hard. And we picked that up by monitoring the performance, looking at the cost there, looking at the correlations, and how they change, and we will change the quantum. But grey goo, you see it every meeting in the performance figures and in every meeting, not only at the performance figures, but also the performance of every single investment that we hold, and we’ll kick it out if it’s not adding.
Nick Heath:
Great. I’ll hold fire on the other question, so I’ll let you move forward.
David Cooke:
Okay. I’ll do a couple more clicks.
Nick Heath:
15 minutes left on the clock.
David Cooke:
Okay. So that’s the alternatives split. Yes, I suppose you do all this chat and then you got to provide some evidence. So many of you might have heard of asset risk consultants, or ARC, and we send, oh gosh, maybe it’s 5,000 anonymised client portfolios, maybe more, to ARC every quarter, and as does the industry, and they say, “Thank you very much.” This is data straight from the custodian. ARC don’t care how anybody labels their portfolios because one person’s balance is another one’s cautious. They’ll chop everything and then they’ll just measure the outcomes. And what you can see here, we took the five-year numbers, this is for balance, but we also got the cautious growth in equity risk profiles, is that our returns have been high, and our risk control, at the top here, this is about risk controls rather than risk taking, has also been very good, so the sharp or the bang for buck is very, very good.
And a large part of that is because of the use of alternatives. That 30% number is quite typical for us in our portfolio, and a lot of that’s been, it helped us during the COVID period and during the Donald Trump related sell-offs. And it’s a similar picture elsewhere, the cautious risk control is a little bit lower, mainly because we’re being compared to cash funds in this portfolio. But the results, if you try and put this into practise, and you say there’s an available universe, and that can help, then can you show evidence that it did help? Because we’ve had quite a ropey five-year period, and we think we can, and that’s the external audit. I think we’ve got another poll. We’ve got another poll?
Nick Heath:
Yeah, so just like poll one, so looking ahead, so thinking about your own business and your own clients, looking ahead, how significant a role do you think alternative asset classes will play in client portfolios in the next five to 10 years? So option A, a core allocation, option B, an important diversifier, option C, a small satellite exposure, and option D, no role at all. So if you could select either A, B, C, or D, 30 seconds on the clock, and we’d love to get your thoughts on that please. So just give it another 10 seconds. Thank you for those who’ve submitted your responses. Okay. Right. Let’s see what the results are, David.
David Cooke:
It’s fascinating. So it’s definitely creeping in to portfolios. I think the industry, in offering simple, cost-effective, easy to understand solutions with evidence that they work, has come a long way in the last 10 years, but definitely in the last four or five. And even to get that number on core allocations is higher than I would’ve thought. And I think this might be just a function of, I think our mentality, because most of, certainly, managers live in the relative world, where you’re compared to how well everybody else is doing. And a lot of the mindset that feels most comfortable with the alternatives world is more in the absolute return mindset. You’ve got to beat cash, you’ve got to beat inflation, you’ve got to make an absolute number in all market circumstances. How do I do that starting with a blank bit of paper?
That mindset finds it easier to embrace the alternatives universe than the relative mindset that just basically takes a look at what everybody else has got and then copies it with a few tweaks on the edges. And that’s fine when it broadly works, but I would suggest that we have seen enough happening in the last five years to have a feeling that the future could be very, very different from the past. If I go on to conclusions, I mean at the end of the day, alternatives are nothing more than just an additional option for portfolio managers to diversify investment risk, which is our job. And there are a wide number of choices available in the UK, in onshore, regulated, liquid, and transparent form. And I’d add with decent track records that give you confidence, and decent communications, and follow-ups, so that you are continuously in touch with what’s going on.
And we’ve always thought that like you and like the clients that understand that one never puts one’s eggs in one basket, it’s all one’s eggs in one basket. It’s the same for investment eggs as well. And we always thought it made strategic sense and that the barriers of gaining diversification benefits by using alternatives had more to do with making an effort, and understanding, and taking time at it, than they did with any intrinsic reason why they wouldn’t work. We’d also suggest that right here, right now, because of the characteristics of where the major asset classes are, that it might make tactical sense to have a few more, compared to what has been in the past. And that is 36 slides.
Nick Heath:
Very good. Thank you. I’m not sure whether Daniel’s going to pop up with some questions that he’s collected, but I might just crack on because we had a couple of questions ahead of time. So the first is, if markets take another sharp downturn, and I think when we say if, we know at some point they will, because that’s just the products of markets, which types of alternative assets are most likely to provide genuine protection?
David Cooke:
Okay. The catch-all answer is, so if markets start falling, that’s stock markets and bond markets, and the prices of the major indices start falling, then the beneficiaries are going to be, principally, those who are short the market or who are in a position to benefit from falling prices. They’ve bought the index and sold it at a pound, and now the index is trading at 90p, so that kind of directional… So you’re talking about people who are short risk, and that would lend it into the hedge category. Now, I think, if it’s a really bad sell-off, the people that are more market neutral, who have totally offset their long positions with their short positions, will do the best.
And that they will continue giving you at least cash returns, over a reasonable period, maybe not over the first day or two, but beyond that. The other category, if you went outside equity long-short, is things like convertible bonds, where some managers are, again, fully offsetting the implied equity value inside the bond, which basically means you’re long an option, that’s your investment risk, you’re long an option on the underlying companies. And option prices move with volatility, and volatility you can think of in the plain English word, the uppy-downiness of prices.
So as long as there’s movement, the option value will increase. And if you can isolate that through a decent convertible bond manager, then you’re going to benefit from movement and dislocations. And a final thing, I left out one alternatives universe, which is the foreign exchange universe, which I suppose you could call an alternative. But one of the things that might work is if we have a sell-off, and it’s UK focused, then the pound is quite likely to fall. So holding things that aren’t pounds, in the olden days that used to be dollars is the universal thing that you hold. Nowadays, I think if we held some Japanese yen, which we do, that that is more likely to go up when the pound is going down because something bad’s happened in the UK.
Nick Heath:
Great. Listen, conscious of time, so I think we’ll draw that to a close. Just a couple of housekeeping things, for those of you that have dialled in live or are going to be watching on-demand, thank you so much for doing so. If you’ve left your details, you might well get some contact from me, so be nice and friendly. I’d love to just get some feedback from you on the call that we’ve just delivered for you and potential future topics. And the final thing is, there’s obviously a PFS event in London on the 13th of November, and myself and my colleagues will be present, so we’d love to meet you there at our stand, and have a chat, and find out more about you and your business. So without further ado, thank you, and have a great rest of the week. Cheers.
David Cooke:
Thank you. Bye.