In the following, I focus on collectables, private equity and hedge funds. You get a good idea of just how small the private equity sector is in Australia compared with the rest of the world, and why super funds are exiting this in favour of offshore markets.
Plenty of other fish for investors to fry
by: Richard Hemming
From: The Australian
October 26, 2011 12:00AM
THE real alternatives.
ACCORDING to Citi Private's Hong Kong-based Asia-Pacific managed investments head Roger Bacon, investors in his part of the world are looking farther and farther afield for returns, a trend being driven by wealthy families rather than by any of the big pension or endowment funds.
This includes investment directly in wine, art and antiques such as watches and furniture, comic books, stamps, classic cars, military medals and even fossils.
"There is a huge amount of focus on this in Asia and in particular in mainland China," Bacon says.
"You can see it in the significant increase in activity in the auction houses in Hong Kong, where there are record prices for lots in many areas."
There is a reason for this interest.
Earlier in the year, a near-mint copy of the comic book Amazing Fantasy No 15, which features Spider-Man's debut, sold for $US1.1 million ($1m). When it first went on sale in 1962 it cost 12c. This equates to a compound return of 40 per cent a year across 50 years.
In the main, however, the returns from collectables are more pedestrian. This is because, like commodities and precious metals, collectable investments don't provide any income and generally increase in value by the inflation rate, which usually trends at 2 per cent to 3 per cent in the long term.
Nick Ryder, the global investment strategist with NAB Private Wealth, says collectables as a class are not for the faint-hearted.
"You have to know something about the collectable, like art or precious comic books, and [if] it's a market you understand, there is definitely a possibility to make money," he says.
For an investment to turn into a collectable of worth, he says, it must often be in mint or original condition; be appropriately insured; and its provenance or authenticity must be provable to verify that it's not a counterfeit.
Unlike commodities, however, their intrinsic value is often difficult to assess, with prices set by demand, supply and quality. And, as rare collectables aren't traded on an exchange, the cost of selling them is high. The prices are mostly decided at auction or in private transactions between collectors, with a specialist dealer acting as a middle man.
Because they are often used to decorate the homes of collectors, the gains on their sale may not be subject to capital gains tax, depending when they were acquired and how much they cost.
However, because of this personal factor, from July 1 this year the Australian government has legislated to prohibit self-managed super funds from investing in collectables if it considers there is not a purely investment purpose.
At the moment, SMSFs in Australia have about $400m invested in exotic assets such as wine and art, representing only about 0.1 per cent of the total invested.
If investors want to invest in real alternatives, often it is best to choose specialist funds, or at least funds that are highly weighted to the asset class, such as AMP's Future Directions Fund, which has an 18 per cent weighting in alternatives.
Exit stage left for private equity
WHEN Super Retail Group, owner of the Super Cheap Auto franchise, decided to purchase sports goods and apparel retailer Rebel Group for $610m, the most relieved people in the room would have been the vendors, the seemingly faceless men and women from the private equity firm Archer Capital.
Possibly they were happy about their $240m profit on the deal, but more likely they were relieved simply to have got out.
Archer faced tremendous difficulties in selling a business whose revenues were declining because of weak consumer demand. The private equity group had originally planned an $800m float in 2009, which it abandoned.
"One of the biggest challenges for private equity is realising investments at a profit and returning funds to investors," says a Sydney-based investment banker who previously ran a private equity fund in London. "You can't just sell these investments on the stockmarket the next day. It has been the industry's biggest challenge since 2008."
In Australia, private equity has about $25 billion in funds under management, according to its industry body, the Australian Private Equity and Venture Capital Association (AVCAL).
Its little brother, venture capital, which purchases companies at an even earlier stage in their development, manages about $2.5bn.
This is very small in comparison with the trillions managed by private equity globally. Wealth understands many superannuation funds are switching out of Australian private equity and into their offshore counterparts. One reason could be the perceived ease of exiting the sector in more liquid markets.
Returns in private equity are very opaque. AMP Capital Investors alternatives manager Suzanne Tavill says she looks for an "internal rate of return" of 15 per cent, which means that if she commits $15m to a fund, across a 10-year period she expects to receive double that amount in cash returns.
Ryder says the returns of private equity greatly depend on the multiples at which businesses are trading at the time the private equity concerns are looking to invest.
He says that "2001 was an awesome year because the multiples were low in the wake of the tech-wreck, whereas the 2007 vintage [which is when Archer bought Rebel] was horrible because the multiples were high. They make most of their returns on the basis of multiple expansion."
Is now a good time to invest?
The jury is out, he says, because of the massive uncertainty in markets: "We'll know in five years. It's like wine, you don't know until you've opened the bottle."
Because of difficulties in raising funds, only the top performers are emerging as survivors, and have successfully raised funds or are in the process of doing so.
These include Champ, Quadrant, Archer, Crescent Capital and Pacific Road Capital.
In view of the protests on Wall Street, and now Sydney's Martin Place, it might help to know that even in the elite world of private equity many are doing it (relatively) tough.
To hedge or not to hedge
IF you read the news on any day of the week, there is a hedge fund manager being prosecuted for something, somewhere in the world.
This month Raj Rajaratnam was sentenced by a Manhattan court to 11 years in prison for conspiracy and insider trading. The 54-year-old was co-founder of the Galleon hedge fund, which at one time managed billions of dollars in assets.
So what is a hedge fund, exactly? To hedge, in the finance world, means to offset risk. Many hedge funds use what they call long-short strategies, which is supposed to reduce market risk, meaning the propensity of markets such as equities to swing up and down.
This sounds fine, but how do they do it?
"They find a bunch of stocks they think will go up, and buy them; and they find a bunch they think will go down, and short them," Ryder says.
"A hedge fund might be net long or net short. [A fund manager] might use futures to balance out. He adjusts the net position of portfolio depending on views on-market, which is called variable beta."
To short means to sell a stock or security without owning the underlying asset. This means you are betting it will go down. If it does, you cover your position by buying it back, hence making a profit.
Private bankers don't think so. They believe there is not nearly as much risk in shorting now as there was in the past, and say they are in the best position to give private investors exposure to shorts. Their point is that these funds may not shoot the lights out when times are good but they protect value in depressed times.
"Hedge funds attempt to capture two-thirds of the market upside but only one-third of the downside," Bacon says.
That means, if the equity markets are up 10 per cent, a hedge fund may be up 6 per cent to 7 per cent.
But if the market is down 10 per cent, the hedge fund would fall to 3 per cent to 3.5 per cent.
Deutsche Bank's equivalent, Joerg Koeppenkastrop, says the hedge funds on the Deutsche platform should give investors a lot more confidence.
"We house about 200 hedge funds and each has an individually managed account. The manager directs Deutsche Bank to purchase and sell securities, so Deutsche is the legal entity."
AMP's Suzanne Taville, an institutional investor, says she believes the hedge fund industry has "cleaned itself up" a great deal, but the onus is squarely on the investor to ensure probity.
"I don't believe you can ever say that [hedge funds] don't have a purpose, but they have to have a valid strategy.
"You have to think carefully about how to incorporate a hedge fund into a portfolio and the nature of the diversification. Some diversify certain risks, but not others."