Second-quarter earnings season has wrapped up. Generally, corporate earnings in Canada and the U.S. showed signs of improvement – albeit at a slower pace.
The worst of the financial crisis appears to be behind us – although business and consumer sentiment remain fragile. The Canadian economy seems healthier – but questions remain about the U.S. and Europe.
Do you see the pattern here?
We seem to be in a “good news/bad news” environment. For “long only” investors – those who invest in individual stocks or diversified stock portfolios to capture appreciation over the mid to long term – this is a frustrating time. Until we see clear signs of a strong economic recovery, most stocks are likely to be stuck in neutral. For those using alternative strategies, however, the story is much different. For example, investors and managers who can sell stocks “short” – essentially profiting from a stock’s decline in value – this kind of market can be very profitable.
The same goes for those who can use options, futures and other strategies to profit from the back-and-forth volatility that we’ve experienced over the past several months.
To that end, I recently asked a handful of alternative asset managers and executives to provide me with a rationale for investing in alternative assets, particularly in light of the challenging investment climate high-net-worth individuals now face.
Scott Morrison, chief investment officer of Wealhouse Capital Management, was the first on my list.
“Some money managers have developed skills that are suitable for different [market] conditions,” he told me.
By limiting yourself to long-only managers, you limit the kind of market conditions you can make money in.
I asked him to elaborate; he asked me to picture myself as a hockey player.
“Imagine other teams were allowed to skate forward and backward, but you could only skate forward,” he said. “Imagine you could only use a wrist shot while others could use a wrist shot, slap shot, backhand or snapshot.”
Toreigh Stuart was next.
The CEO of the Canadian arm of Man Investments, Stuart noted that many high-net-worth investors have become discouraged with traditional asset classes.
“Over the past decade, several of the world’s largest high-net-worth investors have realized a portfolio of traditional assets is not sufficiently diversified to meet medium- to long-term objectives,” he said.
When I asked him to make the case for alternatives, Stuart took the direct approach.
“Most global equity indices have failed to deliver positive returns over the last five- to 10-year periods,” he noted bluntly.
In such an environment, alternative investments, specifically market-neutral and long/short hedge funds, become a lot more appealing.
“The opportunity for an alternative manager to add value has expanded in line with volatility.”
Dave Picton, president and chief investment officer of Picton Mahoney Asset Management, agreed with this general assessment. But he told me a distinction must be made between what he calls “authentic” alternative investments (designed to offer non-correlated performance) and the kind of super-charged hedge funds whose goal is simply to generate outsized returns.
“The original rationale for investing in authentic hedge funds that generate positive absolute returns with little or no correlation to the stock market hasn’t changed,” Picton said. “Increased consistency of returns, lower volatility and lower correlation are strong arguments for including [these] in investors’ portfolios at all times.”
As Picton explained, the past several months of see-saw volatility provide an even stronger argument for including non-correlated alternative investments in the high-net-worth portfolio.
“With equity and fixed income valuations at unimpressive levels, volatility higher than average, and the economic outlook more clouded than normal, it would seem to be an ideal environment to diversify into authentic hedge funds.”
Thane Stenner is the founder of Stenner Investment Partners within Richardson GMP Limited. His column appears every two weeks.