Investment Articles

As part of the continual research that we do on the subject of investing, we have noticed a rising trend in financial advisers and the general public becoming more aware of passive and tracker funds.

We have been involved with this style of investing for many years now, and although it is very plain to us that it (in our opinion) is the most robust and academically proven route to investing one’s capital (as opposed to investing in alternatives, such as ‘active’ funds), it has taken some time to become more mainstream.

Now, however, there is much more coverage in the press about this way of investing, and Richard Saunders, Chief Executive of the Investment Managers Association commented recently that passive funds had experienced a 12% rise in the value of the amount of money being invested in them in 2011 as compared to 2010.

Some of the media coverage included ‘This is Money:

“Investors ditch expensive fund managers for trackers. Despite the vast amounts of money still being thrown at active fund managers, the average UK fund has been beaten over five years by ones which blindly follow the FTSE All Share.”

IFP

Then there was the meeting of the North East branch of the Institute of Financial Planning (IFP) Ray & I attended. There were some good speakers, including Tim Hale, author of ‘Smarter Investing’, whom we have met many times before.

Tim is excellent at pointing out the merits of passive funds and presented to us an example of how hard it is for an active fund to beat a passive fund on average, over time and after costs.

Remember, an active fund aims to beat the market by holding the right shares (and will often trade shares on a regular basis to try and achieve its objective).

A passive fund simply buys the market, and trades very little as it is based on a ‘buy & hold’ strategy.

Tim put a slide up that had 353 dots on it, with a 40 year time period. Each dot was an active fund, and he then clicked the button to see how many of these funds either survived this period (you don’t close a successful fund) or gave a return which could be proved to be performing above average.

Out of 353 dots, only 3 remained!

This IFP day was the day after Ray and I had been on our bi annual trip to London to attend the Dimensional Educational Seminar. This is always well attended and has a high quality of guest speakers from around the world.

One of the speakers was Amit Goyal, a Professor of the Swiss Finance Institute at the University of Lausanne. Amit is an unusual guy, as he is soaked in data but manages to make it interesting!

He is passionate about making known the truths he finds, and this particular talk was on the performance of pension funds using active fund managers.

He used thousands of data sets to show his findings, but the easiest thing to remember was simple. He said imagine there are a hundred active fund managers, and they flip a coin with, say, heads being a performance above average.

We would expect 50% of them being right. So let’s take 50 managers doing the same the next year. If we use the 50% figure, we now have 25 who have performed above average.

I think you get the drift here and what would typically happen year three and four years etc.!

Cutting to the chase, he summarised by saying that “active money management fails to fulfil its promise”.

Others would disagree we hasten to point out, but we feel that the evidence is conclusive in favour of passive and index funds to give you the best chance of investment success.

The Financial Tips Bottom Line

Be careful where you decide where to invest your money. It’s vital that you do (or have someone do on your behalf) comprehensive research so that you know you are investing in the right types of funds, assets and tax structures.

ACTION POINT

How often do you review your investments?

Have some of these been sold to you a while ago and not reviewed since?

Are your funds active funds? If so, how are they performing?

Graeme Urwin is a fee based Financial Planner with Rutherford Wilkinson ltd, and helps UK Resident Doctors and Dentists plan to achieve their financial objectives. Just visit http://www.medicaldentalfs.com where you can request your free retirement planning guide.

Rutherford Wilkinson ltd is authorised and regulated by the Financial Services Authority.

The $32 billion Harvard University Endowment Fund, which generated a return of 21.4% in the fiscal year 2011, has 23% of its investments held in real-assets, which according the CEO of Harvard Management Company; Jane Mendillo, has been a significant contributor to the fund outperforming its benchmark over the last decade by 270 basis points per year, adding roughly $15 billion of value versus what would have been earned by a more traditional portfolio. The University of Notre Dame also holds a significant proportion of its portfolio in real-assets (17.5%), and delivered a return of 21.5% in 2011. The Yale University Endowment Fund delivered a return of 21.9% in 2011, and holds 29% of its portfolio in real-assets, including real estate and natural resources.

This article seeks to review the investment performance of a range of real-assets, compare that performance to the performance of UK equities, and establish the effect of real-assets on the performance of investment portfolios. In particular, this report focuses on the investment performance and impact of farmland, forestry, gold and fine wine. The following analysis suggests that the low correlation of real-assets with other asset classes means that such investments, whilst potentially illiquid, offer an opportunity to reduce risk and volatility whilst also carrying significant potential to generate superior returns.

The following chart demonstrates the compound annual growth rate associated with a range of asset classes over a range of timeframes assuming a single investment made at the beginning of each measured period and ending at the end of 2011. In the case of the IPD UK Forestry Index and IPD Rural investment Index, data was only available until the end of 2010, however anecdotal evidence suggests that performance throughout 2011 has continued at a similar pace and therefore we feel this still offers a true and fair comparison with the equity indices.

Compound Annual Growth Rate (CAGR)

FTSE 100

Gold
UK Farmland
UK Forestry
US Farmland
US Forestry
Fine Wine

FTSE All Share

Cash

5 year

-2.2%
19.4%
12.0%
17.7%
11.9%
4.7%
10.7%
-2.4%
3.8%

10 year
0.7%
18.7%
10.0%
10.4%
14.7%
7.5%
11.7%
1.3%
4.1%
15 year
6.2%
9.9%
-
-
11.9%
7.2%
-
2.4%
4.4%
20 year
6.2%
7.6%
-
6.3%
11.0%
10.1%
-
4.5%
4.8%

This chart tells us that, broadly speaking, real-assets have outperformed UK equity indices and cash over every period considered. Interestingly, equities is the only asset class examined that generates a financial loss over any given period, indicating a higher degree of volatility than its real-asset counterparts. The timing of this analysis plays some part in forming that conclusion due the impact of the recent financial crisis being included in the 5-year performance data. It is likely then that holding real-asset investment alternatives such as farmland, forestry investments, gold and fine wine throughout a range of timelines will have improved portfolio performance without dramatically altering – and in some cases improving – the overall risk profile.

It should be noted that, in the case of the FTSE 100 and FTSE All Share Indices, these numbers offer only a broad view of the performance of an investment in an index-linked investment vehicle, and do not take into account the upside and downside potential of managing a basket of equities and relying to an extent on picking specific stocks in the hope of ‘beating the market’. Nor does it take into account dividend income which could be re-invested, effectively compounding returns and losses. Investment Managers and Investors might feel they are able to outperform the Index through careful stock-picking and active trading/management, although many studies have shown that, over the long-term, professionally managed equities perform only marginally better than the Index in general, and Investors remain exposed to the likelihood or otherwise that individual investment managers will perform consistently throughout the entire term of an investment.

In this report we have compared the investment performance of a range of asset classes including UK equities, farmland, forestry, fine wine and gold bullion. We have also analysed the effect of portfolio diversification through reducing equity exposure and acquiring real-assets. This report has shown:

Real-assets may contribute substantially to traditional stock portfolios
Real-assets have outperformed UK equities by some considerable margin over every timeframe measured
Exposure to real-assets adds meaningful risk reduction, especially during periods of underperformance or volatility in traditional financial assets

It is clear then that diversification achieved through reducing equity exposure and allocating capital to real-assets has, in the cases reviewed in the this report, improved the overall performance of investment portfolios and reduced risk (considered as volatility) between 2001 and 2011, effectively optimising portfolio performance.

One issue with this basic analysis would be a lack of access to investable projects or assets that give smaller Investors direct exposure to the fundamental characteristics that drive returns in the real asset space. Often, farms and woodlands are too large and expensive for single Investors to purchase, and the specific expertise required to improve, develop and operate those assets is also expensive and hard to come by. It is therefore difficult for Investors to allocate smaller sums of capital to these assets outside of restrictive and often expensive and opaque collective funds. Whilst some funds do offer limited access to certain assets, the structure of such arrangements often hamper asset selection, development and management to such an extent as to deliver much smaller returns than direct investments, as revenue is often absorbed into the cost of the structure and on-going management.

Thios article is an excerpt from a report by David Garner is Partner, Investment Partner at DGC Asset Management, an alternative investments boutique specialising in property transactions in the agriculture and renewable energy sectors. To download the full report, please visit the DGC Asset Management website.

This article addresses some of the risks associated with real-asset investment alternatives in general.

As with any potential transaction, all investments carry risk, and in the case of alternatives those risks are often very specific to the asset class, here we address some of the general risks associated with moveable and immoveable properties considered as alternative investments. This risk-set can be broadly defined and categorised as:

Sector Risk
Location Risk
Asset Specific Risk
Counterparty Risk

Sector Specific Risk

As is the case with traditional financial investments, hard-assets carry risks specific to their sector. For example, in the case of agricultural land, Investors must be aware that a variety of exogenous variables can affect the investment performance of the property. Weather, commodity prices, the cost of farming, and agricultural inputs all factor in the revenue potential and profit margins of a farm. As farmland values are dictated primarily by the income producing potential of the asset, poor on-farm performance can adversely affect capital values. The same can be said for gold; during period of growth in equity markets, gold values may fall as confident investors sell their gold and buy into equities in order to capture returns from raising markets. Subsequently gold values may fall as a result. In the case of timber properties, poor house building figures result in a fall in demand for construction timber, and in these circumstances Investor may not be able to secure the price they require for their timber, and may ultimately leave their trees to continue to grow throughout the downturn, choosing instead to harvest when prices are more buoyant and capturing the extra physical growth that has occurred in the interim.

Location Risk

In many cases, especially in the example of real-estate related investments, Investors may choose to acquire assets in countries other than their own domicile. Asset values in emerging markets are often lower, along with the price of labour, and demand in those markets might also be higher, so acquiring assets that form party of the emerging market supply chain is often a strategy to capture superior returns. Whilst man overseas locations offer security of ownership and a transparent business environment, any overseas investment carries risks specific to the country of operation, and developing economies often carry a much greater risk of political interference or security of ownership issues. This extra risk must be factored into the due diligence process, and the potential returns on offer weighed against this inherent risk to capital.

Asset Specific Risk

When acquiring a tangible asset, it is imperative that the investor has access to the requisite skill-set in order to properly identify any issues with the asset itself. This kind of due diligence is essential in order to establish value of money, and avoid costly investments into otherwise useless assets. In the case real estate based investment alternatives, there may be issue with title, access, planning or even financial issue like outstanding tax bills. In the case of niche property like farmland or forestry, there may be specific issues relating to soil quality or water supply which may ultimately cause the property to be less productive and profitable. In the case of other niche sectors like fine wine or collectibles, very specific experience is required in order to identify genuine investment opportunities, and Investors without access to quality, experienced advice may end up purchasing valueless assets for unscrupulous sellers out to make a quick buck.

Counterparty Risk

When investing in niche products, Investor will usually require the services of a professional to advise on the transaction, but also to operate or manage the assets as is the case with real estate or other assets that require ‘trading’ in order to capitalise on opportunities and minimise risk. In these cases, the investor is exposed to the professional capabilities and honesty of their partners, be they forest managers, fine wine investment managers or collectibles experts. Poor advice at the point of investment and bad or incapable on-going management can ultimately destroy the investment potential of any asset. Proper due diligence is required in order to establish the track record of all partners in their respective fields.

David Garner is Partner at DGC Asset Management, an alternative investments boutique specialising in property transactions in the agriculture and renewable energy sectors.

It is now a widely held belief that investing in stocks and other financial instruments in the traditional manner generates an investment return that is driven more by the latest piece of political rhetoric, or the most recent announcement of sovereign debt risk or unemployment figures from some far flung corner of the world, than by underlying company fundamentals like good management and a strong balance sheet. Aside from this inherent volatility, many investors also feel over-exposed to financial markets, especially those coming close to retirement that may have little time left to regain catastrophic losses in any one holding.

This shift in mind-set amongst investors has driven a huge growth in alternative investment management, with most financial institutions now offering investments that are organised and managed in such a way as to attempt to avoid volatility, or generate a return when markets fall, or some other such strategy.

Short Only
Short only funds bet on particular stocks losing value. Investors might buy into a short only fund if they felt particularly bearish (pessimistic) about the short term future of financial markets in general, and some may allocate capital to this strategy as a hedge against the impact of a general downturn.

Ultra-Short Bond Funds
This a type of investment fund that invests fixed-income bonds with very short-term maturities. Such a fund will usually invest in bonds with maturities of around 12 months. This strategy is designed to generate higher yields than traditional bond investing with less volatility.

Market Neutral
Market neutral is an alternative investment strategy designed to profit from growth and depreciation in the value of stocks. Whilst there is no finite technical definition for market neutral investing, for the most part, the overall strategy will involve taking long and short position in a stock (betting both for and against it) in order to maximise the return from making good stock selections and minimise the impact from broad market movements.

Absolute Return
The original name for hedge funds – absolute return investing involves a wide variety of alternative investment management techniques designed to capture financial gains during any and all market conditions. Absolute returns refer specifically to the return of the fund or investment over a given period of time i.e. the actual growth or depreciation. This differs from relative returns, which is a measure of investment returns when compared to similar investments or a sector.

Long / Short
A true mixed bag of investing, long short strategies involve taking long positions in one stock and betting against the value of another stock. In theory, as one sector or company makes a gain, there will be losses in competing sectors, and investment manager aim to identify such opportunities and capitalise on them. A broad example might be an investment manager who thinks oil prices will rise significantly based on some impending political or social crisis, so they might buy into oil company stocks and short stock of companies that rely heavily on oil as a key input in their business.

David Garner is Partner at DGC Asset Management, an alternative investments boutique specialising in property transactions in the agriculture and renewable energy sectors.

It’s been a tough time for investors lately with the world’s major sharemarkets struggling to produce any meaningful capital gain over the past five years.

The disappointment, though, goes deeper: since the start of this century the US sharemarket, measured by the S&P 500 Index, has fallen by 13 per cent, and that’s before taking into account the erosion in value caused by inflation over that time.

In contrast to shares, world bonds have performed spectacularly well (up over 100 per cent) since 2000. The yawning gap in returns between bonds and shares doesn’t depend on the starting point being 2000 either; you have to use more than two decades worth of (US) data before you can show that shares have delivered higher returns than bonds.

It’s perhaps not surprising then that investors have shifted some of their funds away from shares and into bonds. According to data from over 40 countries compiled by the Association of US Investment Companies, investors have reduced their allocation to shares from almost 50 per cent at the end of 2006, to 39 per cent by the end of September 2011, and upped their allocation to bonds and money market investments.

In making the shift, of course, they have contributed to the downward pressure on shares prices and helped push up bonds.

There are at least three reasons behind many of world’s savers shifting from shares to bonds over the past five or more years:

The obvious one is that bonds have simply delivered better returns than shares – in hindsight the shift in funds has been a no-brainer. But could bonds turn from being a no-brainer to being a genuinely stupid investment over the next 10 years?

Another compelling reason for the shift to bonds is simply a flight to safety. Bonds traditionally offer much greater security over the capital value of an investor’s funds in exchange for a lower return than is the case for shares. Given the huge uncertainty that has dogged financial markets for much of the past five years it’s small wonder that investors have withdrawn to the relative safety of bonds. As the turmoil in financial markets fades investors may be inclined to take on more risk and nudge their way back into shares.

A third reason for the shift to bonds may be more fundamental. The demographic bulge in the number of people hitting retirement is likely to see a sustained shift to more conservative investment mandates. As this large age cohort retires their focus will be on the security of their capital rather than the returns they can get from that capital. If the financial crisis has taught us anything it is that returns that look too good to be true, too often are. For New Zealanders that message was repeated loudly by the collapse of finance companies that had lured many retired folk to invest in dubious debentures by offering unsustainably high interest rates.

The first two reasons above rely heavily on hindsight, something that investors find very difficult to shrug off. Investors are told time and again that over the long run shares will produce higher returns than bonds; the basic rationale being that shares carry more risk and therefore investors seek higher returns.

Well, as we’ve seen that has not been the case for the past decade or more, which raises the question: how long is the long term? For a 65-year-old, 10 years may be all the time he’s got left, whereas a 25-year-old can afford to hang on for long-term relative returns to prevail – shares outperforming bonds.

Interestingly, a major KiwiSaver provider has argued that too many Kiwi savers will miss out on investment returns by spending the rest of their working life in the conservative funds they have been defaulted to. The argument rests on these conservative funds returning less than more aggressive share-oriented funds over the longer term.

While past returns are not necessarily a good guide to future returns, the experience of the past two decades surely tell not to make sweeping assumptions about future relative returns. KiwiSaver members who have allowed themselves to be allocated to relatively conservative default funds have done pretty well over the past four years and it would be foolhardy for the Government, or a KiwiSaver provider for that matter, to somehow impose their conviction about future relative returns upon lethargic KiwiSaver members, or indeed presume to know what’s best for individual investors.

Bond yields are historically very low in most, though certainly not all, developed economies. The scope for them to go lower and thus keep delivering the significant capital gains they have done over the past two decades or so is getting pretty slim. Furthermore, if the liquidity central banks have been pumping into their economies finally generates economic lift-off, higher inflation is likely to follow, and that would dent future bond returns. Essentially central banks are trying to engineer an economic recovery by lowering the returns bond investors get in favour of higher returns for businesses taking on debt to expand their business or leverage their existing business – either way cheaper credit should translate into higher share returns eventually.

It would be a pity to see investors once again driven by hindsight to desert an asset class (in this case shares) as it passes through the bottom of its returns cycle and plump for bonds as they pass through the peak of their cycle. The shift back to shares delivering higher returns than bonds will happen – if only someone would tell us when!

Gareth Morgan Investments is an Investment Management company servicing clients who want personal and transparent management of their investments. We manage investment portfolios for individuals and institutions, and we are a KiwiSaver and Superannuation scheme provider.

Visit us at: Gareth Morgan Investments

The European sovereign debt crisis has continued to hog the attention of global markets, with little sign of immediate resolution. The latest development in the drama has been a Europe-wide plan to move to a more centralised approach to setting national budgets in the region. This would involve European governments having to stay under certain deficit and debt limits or face fines for breaching them. It was also agreed that the International Monetary Fund (IMF) will play a greater role in helping out financially troubled countries in the region. The hope is that these changes will be enough to give investors confidence to buy the bonds of Eurozone countries, particularly those with high debt levels such as Italy and Spain.

The problem is that changes to the European Union constitution are required. This in turn will require ratification by the parliaments of individual European countries. Britain has said from the start that it will not be part of the latest proposed deal because it is detrimental to the competitiveness of its financial sector. And although the other 26 European nations have given their initial approval to the deal, the fear is that some of them will be unable to ratify it.

In the meantime the financial state of the European banking system has deteriorated substantially. In response to bank pressures, the European Central Bank (ECB) and the US Federal Reserve have pumped an extraordinary amount of emergency short-term funding into the European financial system. So far this has had only limited effect on bank funding costs and credit pressures. However, one side-effect of the ECB actions has been to support European bond markets through the back door. Banks are taking advantage of the cheap short-term funding available at the central bank and then buying European government bonds with much higher yields, thereby making sizeable margins.

Despite ECB efforts so far, many investors and commentators are calling for a “big bazooka” – aggressive ECB buying of Italian and Spanish government bonds. This would lower the interest rates Italy and Spain pay on their debt even further, making the debt easier to service. It would help support the value of those bonds, helping to protect the capital of European banks. But Germany, and the ECB itself, is vehemently opposed to such action. Their fear is that lowering the interest rates on European sovereign debt will take pressure off governments to undertake the reforms required to get their finances on a truly sustainable footing.

So the crisis stumbles on. My view is that the situation will muddle along until such time as markets have sufficient confidence that Eurozone members are on the road to consummating a European fiscal accord. This could be around March/April next year. In the meantime the ECB will continue to provide backdoor support for sovereign bond markets, although this may become more direct once the accord has been ratified by a critical number of European countries. Europe is heading for recession next year as a consequence of the contraction in bank credit and the uncertainty stalking the financial system.

There remains a small but significant risk that the crisis could deteriorate to the extent that the European banking system begins to crumble – some banks either go bust or have to be taken over by their governments. In this case the ECB, IMF and national governments, in cooperation with other central banks around the world, would intervene massively to support banks. Under this scenario a break-up of the Eurozone and sovereign debt defaults would create havoc in financial markets. Global growth would certainly suffer under such an outcome.

On a positive note, it is now clear that the US is no longer heading for recession. In fact, indicators over the past few months suggest the US economy is gradually building momentum and is likely to reach annual growth of 3-3.5% by the end of this year. And although China’s economy has slowed to around 9% annual growth, inflation has abated, which gives the Chinese authorities room to free up access to credit to stimulate activity. These developments will blunt the negative influence of Europe on global activity.

Europe’s woes will continue to emphasise the risks of excessive debt whether that be government, business or household debt. New Zealand government debt is relatively low, but rising as we continue to run significant budget deficits. New Zealand households are still carrying a high level of debt primarily backed by property. This is the age of deleveraging or debt reduction; we ignore the message at our peril.

Gareth Morgan Investments is an Investment Management company servicing clients who want personal and transparent management of their investments. We manage investment portfolios for individuals and institutions, and we are a KiwiSaver and Superannuation scheme provider.

Visit us at: Gareth Morgan Investments

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.

The most popular type of investments that people make are in collective investment schemes. This makes a lot of sense as it reduces risk for the investor.

Collective investments are funds where the monies of a large number of investors are pooled together under professional investment management. The investment manager then acts collectively on their behalf.

The most popular collectives are unit trusts, investment trusts and Open Ended Investment Companies (OEICs). Then there are offshore funds, with-profit funds, commercial property funds, corporate bond funds, exchange traded funds (ETF’s) et alia.

Of course, some people prefer to invest direct. This obviously takes a lot more time for them to do all the research – ideally beyond just reading the financial press. The problem is that, as several independent research studies show, people who invest direct tend to do worse than institutional investors for various reasons, mostly due to their own actions. These include lack of diversification, compulsive trading, buying high, selling low, going by hunches and simply by responding to media and market noise.

The latter often means that such investors end up investing on the basis of past performance. They read about good past performance for a 12 month period and then invest, when there is no certainty that this will lead to better returns the following year.

Financial markets are cyclical and the key to successful investment (as opposed to day trading) is not timing but patience. A buy and hold strategy may not be as sexy and exciting but it seems to work most of the time. On the other hand, becoming addicted to trading does not help in most cases.

A lot of the above behavioural traits that end up causing investor problems stem from over-confidence. In reality, what is required for most individual investors is to get their egos and emotions out of the investment process. One answer is to distance themselves from the daily noise by talking to an independent financial adviser, to help stop them doing things against their own long-term interests. It is quite likely that the financial adviser will recommend collective investments.

The major benefit of collective investments is that they can reduce the risk of investing, by spreading the risk of their investment. The fund manager is able to purchase a far greater number of investments than the individual investor possibly could. Because of this, the possible impact on the collective investment fund caused by one particular investment performing badly is low, as it forms only one small part of a much larger investment portfolio.

Collective funds also provide a higher degree of diversification. For example, if you were looking to invest in UK smaller companies, it would be impractical (in terms of costs and research time) to invest in more than a couple of companies. A fund manager, however, can buy shares in many companies and spread the investment further. The fund managers will also have the in-depth knowledge plus a team of researchers behind them to monitor the sector for new opportunities as well as potential problems.

A further benefit is that fund managers have access to markets and instruments where individual investors don’t have the knowledge, capital or perhaps even the legal right to invest. This includes hedge funds, emerging markets, private equity situations and complex derivatives.

With thousands of collective funds to choose from, the question is how to pick the best funds for you? It is not an easy process, even for professionals. But getting quality financial advice from an independent financial adviser should certainly help you with your overall investment planning process.

Chris Flood, MA (Oxon), MBA, is a marketing and management consultant based in Bristol UK. He writes articles on investments and financial planning as well as other subjects. To discover more about income investing, please go to http://www.kelland-hale.com/collective-investments.asp

Further information about Kellands Hale and its services can be found at http://www.kelland-hale.com/

The Thrift Savings Plan currently offers ten investment funds. Five are U.S. and international stock and bond index funds: they replicate the performance of broad market indexes. The other five TSP funds, the Lifecycle Funds, are professionally managed portfolios which consist of a specific target allocation of the 5 individual TSP index funds.

The TSP Funds contain a diversified portfolio of thousands of individual stocks and bonds. Investing passively in index funds such as these is generally considered to be a good retirement savings strategy. The alternative is for you or an investment manager to actively pick individual stocks and bonds to buy and sell. Apart from being impractical for individual investors, this latter strategy usually also leads to inferior investment results: research has shown that most professional active fund managers under-perform a passively managed portfolio of index funds such as the TSP funds.

Here’s a summary of the five primary TSP Funds:

The G Fund is invested in U.S. Treasury securities which are guaranteed by the U.S. government. The nice thing about this fund is that it’s practically risk free (your investment is guaranteed not to lose any money), and yet the interest rate is substantially higher than what you would earn in other safe investments like bank savings accounts, certificates of deposit, or money market funds. If you are very risk-averse, this is definitely the place to park your savings.
The F Fund is a bond index fund, invested in high-grade U.S. government and corporate bonds. Its performance is very similar to the private sector iShares Barclays Aggregate Bond ETF.
The C Fund is a U.S. stock index fund that mirrors the returns of the S&P 500 Index, which consists of large U.S. corporations. Its returns are essentially the same as the SPDR S&P 500 ETF.
The S Fund is invested in the stocks of small to medium-sized U.S. companies. It’s designed to complement the C Fund, so if you invest in both, you basically own shares in almost all U.S. stocks. There aren’t a lot of index funds that track these companies, but if you own both the TSP S Fund and C Fund, then your investment returns will correlate closely to a broad U.S. stock market index fund like the Vanguard Total Stock Market ETF.
The I Fund is allocated to international stocks. It allows you to diversify your portfolio by investing in the stocks of companies in more than 20 developed countries in Europe, Australia, and Asia. There are several private sector equivalents to the I Fund, including the iShares MSCI EAFE Index Fund.

The other five funds, the TSP Lifecycle Funds, consist of professionally managed investment portfolios designed to meet investment objectives for a specific target date (the date on which you plan to begin withdrawing your money). The L Fund assets are invested in the individual TSP funds (the G, F, C, I, and S Fund) according to a target portfolio allocation which is adjusted every 3 months. The target allocation starts out risky, with a large percentage of stock funds such as the C, S, and I Fund. As the target date approaches, each L Fund becomes gradually more conservative, by shifting a larger portion of your assets into bonds such as the F Fund and G Fund. This investment strategy assumes that, while you’re still a long time away from retirement, you’re willing to take on greater risks in order to increase your potential investment returns. Also, while you’re still at the start of your career, you have a longer period to recover from potential investment losses, considering that you’ll continue to make monthly contributions to your account for many years.

Depending on your personal circumstances and target retirement date, you choose one of the five L Funds: L Income, L 2020, L 2030, L 2040 or L 2050 Fund. The L Income Fund is the most conservative asset mix and assumes that you’ve already started withdrawing your savings. The L 2050 Fund is the most aggressive allocation, currently 90% stocks and 10% bonds.

Benefits and Disadvantages of Investing in the TSP Funds

Many investment advisors recommend that for long-term retirement savings, you buy and hold a low-cost, broadly diversified portfolio of domestic and international stock and bond index funds. With the available TSP investment funds, you can do an OK job at this. By investing in all five individual TSP funds, or in one of the Lifecycle Funds, you’ll have a decent portfolio, with an ownership share in thousands of U.S. and international stocks and U.S. bonds. And the TSP funds have extremely low annual expense ratios, several times lower than comparable private sector mutual funds and ETFs, keeping more of your money working for you.

So what’s wrong with the list of currently available TSP investment choices? Some investors want to own Emerging Markets stocks (in addition to the Developed Markets international stocks in the TSP I Fund). Or an allocation to real estate (REITs), or inflation-protected securities (such as TIPS). And some would even like access to more exotic investments like international bonds, high-yield bonds, and other hedges against inflation (commodities and precious metals like gold and silver). Professional advisors would differ on how suitable these investments are. Most would agree that TIPS are a good idea, and for more risk-tolerant investors, perhaps a small allocation to REITs and Emerging Markets stocks.

One great benefit of investing in an L Fund is simplicity: it’s a “set it and forget it” investment plan. You choose an L Fund, determine your monthly contributions, and the fund administrators take care of everything else: regular portfolio rebalancing, and gradually adjusting the asset allocation as you approach retirement. But there are also a few downsides. First, the L Funds with the longer time horizons are fairly risky allocations (for example, currently 90% stocks and 10% bonds for the L 2050 fund), and you should make sure that you can stomach the inevitable volatility as a result of owning a portfolio dominated by stocks. If you’ve owned stocks for the past decade then you already know this: it can be quite a bumpy ride. Also, some investors want more control over their exact portfolio components, when to rebalance, and how soon to start shifting the allocation to a more conservative asset mix as they approach their planned retirement date. Some investors also prefer a tactical asset allocation, shifting their mix based on asset class trends, economic circumstances or other criteria. Owning a portfolio of the individual TSP funds will work better for these investors.

Learn more about the TSP Funds and get daily price and performance updates at http://www.tspfolio.com/tspfunds

Individually Managed Accounts (IMAs) and Separately Managed Accounts (SMAs) both offer investors a highly transparent managed share portfolio while avoiding the tax distortions that come with pooled investment vehicles such as managed funds.

However, there are some important differences between individually and separately managed accounts and while they may sound very similar, these differences can have a significant impact on investment performance, suitability, and tax effectiveness.

In General, Separately Managed Accounts are a good alternative to managed funds for many investors, while investors with $1 million or more, are likely to find the features of an IMA more compelling.

Key differences between the two types of managed accounts rests in their approach to building an investment portfolio.

SMAs are constructed with a ‘model portfolio’ where each investor receives precisely the same portfolio, based on a template created by the fund manager. IMAs however, are constructed individually for each investor, although each account will share some common holdings. These two approaches have some important differences:

* Investors in a SMA may buy stocks that have already enjoyed most of their returns, but remain in the model portfolio to avoid realising capital gains tax. IMA investors however will receive a portfolio that is assembled incrementally, as attractive opportunities arise.

* For the same reason, new investors in Separately Managed Accounts will receive a larger position in stocks that have already performed well, while IMA investors are likely to receive larger holdings in stocks the investment manager believes will perform well in future.

* IMAs also provide the ability to tailor the portfolio to the investor’s circumstances. For instance, an IMA manager may place more weight on generating franked dividends for a SMSF, while long term capital appreciation could be more valuable for an investor with a high tax rate. These differences in investment management help produce good after tax results for each investor. Since every investor in a SMA receives the same portfolio, the Separately Managed Account manager cannot factor individual considerations into their management.

* Both structures will allow the transfer an existing portfolio, with the IMA providing some additional flexibility and tax advantages. When importing an existing portfolio into a SMA, only those shares contained in the model portfolio will be retained and only to the proportion held in the model portfolio. Therefore, investors may still realise capital gains when entering an SMA. Conversely, a diligent IMA manager will adapt the existing portfolio over time and with consideration to tax events.

* For investors wishing to exclude individual stocks or sectors, an Individually Managed Account manager will hold alternative positions, while the SMA will generally hold cash in lieu of the excluded positions. This can have a significant impact on the portfolio’s overall returns.

In executing trades, SMA investors will generally receive ‘at market’ prices on their transactions, while an IMA manager may attempt to get best execution and/or exercise discretion over the timing of buys and sells.

Service levels are also different, with Separately Managed Account investors receiving a service akin to a managed fund. while Individually Managed Account investors have ongoing access to the fund manager responsible for their portfolio and will likely receive personalised reporting.

PPM