Should you hold Alternative Investments in your portfolio?
So you’ve decided to reduce your exposure to equities in order to avoid the price volatility that seems to be driven by the latest piece of political rhetoric about national debt or economic growth. You’re no longer seeing the value of your investments rise and fall by considerable margins on a daily basis, and you’re sitting on a nice pile of ’safe’ cash. But you probably also need to find a home for your capital where it will grow at least in line with inflation, hopefully generate some income, whilst sharing little correlation with the performance of equities, bonds and other traded financial instruments.
So now is the time you start to consider alternative investments. but where do you start? Do you buy fine wine, rare stamps, farmland, timber or any other of the plethora of emerging alternative investment asset classes currently being touted as the ‘perfect’ investment?
I suggest that the first place one should look should be to their requirements, really establish the end goals you wish to achieve, and the limits you have in terms of liquidity, asset allocation for your alternative investments (as a % your total portfolio) and risk. From there you can, with enough research, discover which asset class might be the right alternative investment for you.
Let’s look at a case study, and see if we can match the Investor to an alternative investment asset class that offer the performance e and characteristics he or she is searching for.
John has a total pension portfolio of £250,000, held in a flexible Self Invested pension Plan wrapper (SIPP). John chose to move his assets into a SIPP some time ago in order to take more control over decisions affecting his investments, rather than be reliant on a Financial Advisor who can only advise on a couple of asset classes – equities and bonds.
John pulled 50% of his portfolio into cash 12 months ago, with the remainder held in defensive stocks and bonds. He has decided to allocate 10% of his overall pension to non-financial, real-asset alternative investments. He does not need income, and he is prepared to hold an asset for up to 10 years, aiming to capture capital growth. John has self-certified as a Sophisticated Investor, but does not wants to invest in funds, he wants tangible assets.
Taking into account John’s position and requirements, it might be suggested that the following alternatives may be a good starting point for Johns research process:
Fine Wine
Land – Particularly productive agricultural land
Timber Properties
Collectibles
All of these assets display certain characteristics that John might find particularly appealing. Fine wine – when selected and managed by an expert – has been shown to deliver returns of up to 20 per cent per annum. The forward looking story looks good too, as increasing demand from Asia, particularly a growing wealthy class in China is demanding more fine wines that the world can currently produce, and they are prepared to pay increasingly large sums of money as wines get older and rarer as more of a particular year is consumed. This increase in demand for a finite asset is what drives capital growth, and a good wine investment manager might help John to pick and choose a suitable portfolio, or cellar’ of wine and also advise, perhaps on a discretionary basis, when to buy and sell to maximise profit and minimise risk. Also, the performance equities has absolutely no bearing on the investment performance of fine wines, allowing John to collect long-term capital appreciation.
Much the same thing can be said for collectible such as rare stamps, where again demand is driven by increasing rarity and increasing demand from wealthy overseas and domestic collectors and investors.
Agricultural land also benefits from increasing demand, as populations in developing economies grow and incomes rise, they demand more protein (meat), which requires many more resources to produce than their traditional grain-based diets. It takes about 3kg of grain to produce 1 kg of beef, so this adds considerable pressure to current agricultural productivity. At the same time we lose millions of hectares of arable land every year to urbanisation, degradation and climate change, so it is likely that farmland will continue to become more valuable over time, again giving John the long-term capital appreciation, as well as separation from financial markets that he requires. This would also generate income from farm rents, or perhaps even through a joint venture farming agreement that would allow John to share in the profits from harvesting.
Forestry investment may also offer John a potentials alternative. Essentially, purchasing a timber-producing property, through leasehold or freehold, and simply sitting back and watching the trees grow bigger and more valuable each year, a biological process that cannot be interrupted by an economic crisis. The actual price of timber also moves every year, having risen by an annual average of 6% for the past 100 years. This means John capture true growth in its truest sense. A huge number of institutional investors are investing in forestry, including pension funds, university endowments (Harvard and Yale to name but two) and hedge funds, all of which are investing in forestry for long-term capital growth. Again, the same principles of supply and demand hold true for forestry. We require more timber as the enormous populations of China and India enter into their most aggressive and resource-intensive phase of growth, requiring more timber for paper, biomass and construction, whilst at the same time natural forests are now protected, creating huge demand for sustainable sourced plantation timber.
In summary, there are a range of alternative investments for John to consider, and really the best thing for him to do would be to conduct his own research in to each subject, and speak to a range of Advisors with specific experience of each individual asset class and choose to work with a professional that can substitute a good track record of investment selection/management for the options he chooses. So, speak to a few fine wine brokers and measure their pitch against the knowledge gained from researching the asset class. Speak to a forestry investment advisor and agriculture investment advisor, and choose to work with someone that knows their sector, and has delivered success for Clients previously. Heck, why not ask to speak to any potential investment partner’s previous clients; I’m sure that any Advisor worth his salt would be proud to have a Client sing their praises.
David Garner is Partner at DGC Asset Management, an alternative investments boutique specialising in property transactions in the agriculture and renewable energy sectors.