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2 April: diversification through alternative investments

6 mins
Rebecca Cretney, 
April 2020
2 April: diversification through alternative investments

One of the first lessons you are taught when studying anything investment related is the role diversification plays. For my investment exams, I was taught a diversified portfolio consisted of around 20 stocks ‒ a mere nod to today’s view. Instead, your portfolios – if you are a client of Nedbank Private Wealth that is – are invested across thousands of companies.

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We diversify across investment styles, countries, industry sectors, types of investments, as well as currencies – an approach that we believe makes a material difference to portfolios given the global reach of our strategies, and yet one that sets us apart from the majority of our peers. 

Today, I would like to explore our so called ‘alternative investments’, which are another way in which we diversify our multi-asset portfolios. These offer an exposure to a varied array of real assets, which although very different in nature, have a series of characteristics that bind them together, or a common thread, if you like. They offer high and dependable yields, they are backed by either real assets or contracts (often government ones) and quite often enjoy some form of inflation protection mechanism. The strategies we favour are invariably simple, liquid and transparent.

Investment trusts have had a long and successful history, dating back over 150 years. The structure allows its manager to benefit from a fixed pool of capital. But you need to be very wary of the type of investment trust you chose. We specifically chose closed-ended funds (as opposed to open-ended ones) because shares in the company are bought and sold through the London Stock Exchange, and not sold back to the fund managers (which would be the case with open-ended funds).  This is very important if you have a real asset, especially in times of volatility, as our managers do not have to worry about trying to sell assets under fire and can remain focused on their long-term strategy and value. 

Although during the COVID-19 crisis every investment came under fire, our alternatives (in aggregate) weathered the storm better than global equities. Not only did they drop less, they have also recovered faster, with many of them already trading back at pre-coronavirus levels. 

Because we place such great emphasis on diversification, we have taken a broad-based approach through five different alternative strategies.  Although these will vary over time as the economic environment changes or new opportunities are identified, I wanted to expand on our current themes:

 

Renewable energy infrastructure

If you cast your mind back to before the coronavirus crisis, which seems like a lifetime ago now, global warming was one of the hottest topics of the hour. Bizarrely, the virus is having some positive impact on the environment, but once life normalises finding renewable sources of energy to support what could well be a rather different looking lifestyle will continue to be important. 

Renewable energy infrastructure funds typically generate their income from wind and solar energy farms, dotted across the UK and Europe, and are usually backed by attractive government price guarantees. Aside from the significant upfront investment cost of building these farms, the main inputs of wind and sunlight are free. We also believe their income should be well insulated from the fall-out of COVID-19 and, given the renewable energy sector is one likely to see growth and increased attention over the coming years, ours are investments with long-term value, as well as green credentials.

The share price of the investment trusts which provide your portfolio with exposure to these sectors has already returned to normality and the income derived from these holdings has continued uninterrupted.

It’s worth noting that all of the renewable energy investment trusts have already returned to normality, as they are trading at premiums to the previous levels, while the income derived from these holdings has continued uninterrupted.

 

Commercial property

We have a relatively small investment in prime UK commercial property through a very high quality, diversified commercial property fund.  The fund invests principally in three property sectors: office, retail and industrial. It also has an allocation to leisure, residential property and student housing. The fund owns St Christopher’s Place, for instance, which has shops, offices and restaurants just off Oxford Street. The fund has a low loan-to-value of around 21%.

Clearly this has been impacted by COVID-19 and we expect property valuations to be lower for the next few months. However, the discount reflected in the share price was, to our mind, completely disproportionate and afforded an opportunity for us to add to our positions. Investors should not get sucked in to linking the high profile closure of opened-ended funds with this trust, which is closed-ended.

 

Asset-backed lending

What do companies do when they want to borrow money but their requirements or the asset they offer up as security don’t really fall within a bank’s typical criteria? When, despite having a sound business model, the lending computer says no? They can approach a specialist fund, offering up assets or future earnings as security for the loan. 

We invest in two such funds, which have a broad portfolio of loans across various different sectors, ranging from social infrastructure such as student accommodation or high-end shared living to energy infrastructure.

Clearly cash flows will be a concern for companies across most sectors, so dividend flows will be temporarily disrupted. But given neither of the funds we have invested in have any debt, and have very low day-to-day costs, any issues will be dealt with in a measured approach, with the knowledge that all the loans are backed by collateral and that over time, the fund’s share price will return to normality.

 

Song royalties

Last, but definitely not least, as I detailed in our communication last week, is Hipgnosis, which owns the rights to thousands of well-known songs, from which it receives frequent cash royalties. Given it has a strong, reliable and growing cash flow, which we believe is going to benefit from the current lockdown, as well as to the overall growth of revenues from music streaming, the fund price is already back to its pre-COVID-19 level

 

Tolstoy’s War and Peace reminds us that the two most powerful warriors are patience and time. Although we find ourselves ‘at war’ with a virus, I feel at peace. Peace about the long term resilience and success of our alternative investments. You may argue that this is a very bold statement to make at such a time of uncertainty. But in time, this period will pass, and as life returns to normal, the quality of our investments will undoubtedly reassert themselves.

I also feel peace about our investment process, despite the current roller coaster ride. We have a robust, disciplined investment approach, designed to meet our clients’ long term financial objectives. In addition to our diversification tenet, your portfolio remains liquid and positioned for the long term. We are confident that our rigorous monitoring and valuation process is robust and are happy to reassure you of this and go into more detail over the phone or via a video chat, ahead of the time when we will once again be able to meet face-to-face.

Clients of Nedbank Private Wealth can get in touch with their private bankers or relationship managers directly to understand how their portfolios are responding to market events or call +44 (0)1624 645000.

If you would like to find out more about how we can help you manage your investments, please also contact us on number above or email us.

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Rebecca Cretney

Rebecca Cretney

Investment Counsellor

Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services. She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist. Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.

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