So we double-dog dare you to try and say the title of this piece three times fast! Much has been made about the need for investors big and small to look at non-traditional investments following the portfolio debacles of 2008 and 2009.
We caught up with Sona Blessing to discuss her views on the subject and her new book, “Alternative Alternatives, Risk, Returns and Investment Strategy”
AAA: What are alternative alternatives?
Blessing: My working definition for the book has been based on unconventional, non-traditional, non-main stream hedge fund investments and strategies whose risk profiles and return drivers are atypical, unique and or idiosyncratic in nature. Given that financial literature tends to define alternative investments as a negation to traditional assets or, in other words, if core asset classes include equities, bonds, real estate, commodities, currency, and if these are compounded by their respective derivatives, then alternative investments are the resulting permutations and combinations thereof – such as hedge funds, structured products, etc. If we were to take this thinking a step further, then ‘alternative alternatives’ could be considered a “negation” of alternative investments.
Source: Sona Blessing
AAA: Why alternative alternatives?
Blessing: The raison d’être for alternative alternatives and my hypothesis has been:
In theory, market risk (also referred to as systematic risk = or beta) can be isolated and measured. By default, a risk originating outside financial and capital markets (as in nature) should not be affected by it. Clearly, neither the biological growth of trees nor the occurrence of natural/ weather phenomenon are influenced by events playing out in financial and capital markets. Quite simply tress will continue to grow in volume and value provided they have adequate sunshine, water, air and the appropriate soil conditions. Natural catastrophes such as earthquakes will continue to strike without our ability to accurately time and or predict their occurrence. Potentially each of the above, if made investable can provide exposure to a specific, non-replicable, unique risk premia that could deliver returns.
Put differently, if the source of risk (inefficiency/ies – risk premia) rest(s) outside the domain of mainstream financial markets, then it should be insulated from the vagaries of the financial market – as it has nothing to do with this market. It is important to recognise that even though the source of risk resides outside the market, the risk is real, and if borne, so are the prospects of being compensated for it. Even so, an exposure to such risk is not immune to a performance pull-back, as its risk profile is different and its return drivers or triggers are idiosyncratic.
In practice and in the real world it is virtually impossible to get “exclusive” exposure to naturally occurring sources of risk. But exposure to such risk can be calibrated – and if taken on, offers access to a source of partially inhomogeneous return.
Similarly research I have undertaken reveals (affirmed by the occurrence of the credit and sovereign debt crisis) that select sources of idiosyncratic risk although not originating in nature; are equally capable of offering unique risk-return profiles, provided the risk transfer process has been structured “correctly.”
AAA: What are their peculiarities?
– Nonreplicable risk or risk that cannot be replicated easily.
For example, it is difficult to replicate the actual occurrence of a natural catastrophe such as an earthquake or the biological growth of a specific 25-year-old tree.
For instance in case of asset based lending strategies such as in trade finance, each loan is unique – for a specified purpose and period in time, and hence needs to be analysed, assessed and evaluated for its “risk”-return profile on an individual basis.
Their markets tend to be inefficient and are driven by factors such as, in the context of investing in collectables, who is looking for which painting, rare wine bottle? How much are they wiling to pay? Who is a distressed seller – is it a verified ”original”? How scare is it?
In the context of micro life settlements – longevity/mortality risk – each policy is unique or in the case of asset-based lending strategies, each loan needs to be evaluated and structured individually.
– Low-to-no correlation
As in the case of naturally occurring catastrophes, such as winds in Europe, and an earthquake occurrence in the U.S., Japan, etc.
AAA: How have these assets and strategies performed through the most recent financial crisis?
Blessing: A majority of these alternative alternative assets and strategies have continued to deliver ”characteristic”, in-line, positive performance irrespective of the credit crunch and the ensuing recessionary environment.
– Timberland has continued to grow increase in volume and value terms.
– Insurance linked strategies (life and non-life) have delivered a positive performance also for the year 2008, including those that partially suffered owing to the collapse of Lehman (counter-party risk exposure as Lehman was one of the custodians of the special purpose vehicle accounts).
– Loan-based lending strategies have even benefited from the enhanced rigidity in regulation applicable to banks and other formal money lending institutions.
– Collectables of historical significance have maintained or appreciated in value.
– Volatility trading strategies have, depending on the underlying traded, and selectively, delivered in-line performance.
– Behavioral finance conditioned funds – selectively – have also delivered in-line performance.
On occasions where there has been a performance setback, it has been largely owing to structural issues. Paradoxically, even though most of these strategies are ”stereotypically” perceived as being ”illiquid”, if needed to be exited they have proved to be remarkably stable and ”liquid”. In spite of this fact, it is important to be realistic about managing their liquidity.
Understanding fully an asset’s or the strategy’s source of risk (its origin), characteristics – peculiarities (including valuation methodology, illiquidity, uniqueness), return drivers, persistence, scalability, shortcomings, terms and conditions – systematically isolating them from the risk posed by the investable wrapper/investment vehicle (structural) – operational, legal, regulatory, tax, currency, manager, market risk, liquidity, etc. – is imperative.
Alternative alternatives’ underlying investible source of ”pure/core” risk has, and is capable of performing (positively), given its fairly high ”certainty of returns dimension.” These assets and strategies can offer ”real” diversification and provide a differentiated risk-reward profile.