Participants: Marilyn Trentos, vice president & investment advisor, RBC Dominion Securities. Nicolas Del Sorbo, senior vice president & senior investment advisor, HSBC Securities (Canada) Inc.
Moderated by: Vikram Barhat
How has the recession impacted alternative investments?
Marilyn Trentos: I think the recession and, more importantly, the meltdown in the markets it caused, has impacted all investments and the psychology of the investor. The alternative investments, or specifically hedge funds, whose claim was a hedge and hence a market-neutral stance, proved that more often than not the investment wasn’t as neutral or safe as thought and the investor wasn’t as protected as believed. The recession exposed these investment vehicles as aggressive, volatile and risky – qualities not being sought out by the typical investor following the downturn.
Nicolas Del Sorbo: It’s affected them very negatively. What came before the recession unfortunately were bad markets, [which] were very detrimental to hedge-fund investing. A lot of the hedge funds that were being sold were really long-only equity funds with a lot of leverage. And in a rapidly declining equity market, those funds got wiped out, investors got wiped out, and certainly that led to alternative strategies being viewed very negatively. Large blowups, like the Madoff affair, certainly didn’t help the equation.
How important are alternative investments in diversifying a portfolio?
Trentos: My view is that a client can be well diversified without any direct holdings in alternative investments. In other words, NOT that important.
Del Sorbo: I certainly think they’re important. “Alternative investments” is a fairly broad category. It includes things like hedge-fund investing, real estate, managed futures, private equities, commodities, etc., so the alternative equity space is fairly broad.That space continues to be very important for high-net-worth investors and institutional investors.
How much of a portfolio should be allocated to alternative investments?
Del Sorbo: A portfolio manager has to make a call on that. Having said that, there are some rules of thumb: a 10% to 15% allocation to alternative investments seems to be an accepted [strategy] for the portfolio weighting. Alternative strategies really become part of clients’ portfolios as they become larger.
What alternative investments should you hold?
Trentos: For the average investor, alternative investments such as gold and real estate increase the diversification and should be held in the average high-net-worth individual’s portfolio.
Del Sorbo: Again, that’s a portfolio manager’s decision, but certainly in our view, we continue to think that hedge funds can have and should have a position in client portfolios. They should be true hedge funds – hedge funds with a proven track record of giving you diversification from your traditional equity and bond holdings.
What shouldn’t you hold?
Trentos: Alternative investments are often illiquid and not priced daily. Many of the alternative investments are complex and deploy sophisticated option strategies that most can’t explain, let alone understand. We counsel all our clients to fully understand the investments in which they’re participating. If a client doesn’t fully understand the investment strategy, they shouldn’t hold it in their portfolio.
Del Sorbo: Certainly the lessons of the past several years have showed us that hedge funds that tend to be long-only hedge funds, and use or implement a lot of leverage, [are]ones that should be approached with caution. Those ones tend to do particularly well in up markets, because that’s when leverage is working for you. But they can be very dangerous when markets are moving rapidly down.
How will increased regulation affect alternative investments?
Trentos: In general, any regulation or tightening of the rules surrounding these complex investment vehicles is a good thing and should enhance the protection of the investor. The unregulated nature of hedge funds lent itself to increased risk, increased leverage and increased losses. While over-regulating could make these vehicles impossible to manage, there is a fine line between no rules and protecting the investor.
Del Sorbo: That’s a forward-looking question. My thinking is that we’re going to have both positives and negatives. The positives will be that regulators will make hedge funds more difficult to access and less mass-market, and may return hedge funds to their original roots – an institutional-type product. I think regulators have realized that some people have maybe invested in these products not knowing what they were buying, and the results have been challenging for everybody. One of the negatives might be over-regulated hedge funds, which might limit returns if hedge fund managers don’t have the full toolbox to operate [with].