Portfolio Allocation (XIII – Alternative Investments)

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Portfolio Allocation (XIII – Alternative Investments)

Continued from here.


For now obscure reasons, this series was originally called ‘Hitting the Century‘. At this point, I’ve bowed to the inevitable & given it a more sensible name. It’s still a v leisurely stroll through the topic of portfolio allocation. I usually touch on stocks I actually own quite briefly, as the main objective is to expand on the logic (& attractions) of my specific portfolio allocation. Also, since my approach to investing is better described as thematic rather than (say) geographic, I generally highlight a selection of stocks which may exploit particular theme(s). As a reminder, here’s the allocation pie-chart I’ve used for the series:




Hedge (7%):


Hedge funds were a far larger component of my portfolio. This reflected a gradual migration over the years from open-end funds (many moons ago), to closed-end funds & investment trusts/companies, and finally into hedge funds. This was accompanied by an increasing reluctance to delegate my investing & investments. [Which may surprise you, as investment companies still play a significant role in my portfolio. However, this tends to now reflect my delegation of a specific/specialist investment theme - or simply the selection of a fund itself as an attractive investment, due to the presence of a large discount/catalyst/etc.]. Hedge funds, however, appeared to potentially offer the magic combination of lower volatility/correlation & better long-term returns. Sure, maybe they’d under-perform a bull market, but who cared – they simply ignored down markets, right?!


Of course, the financial crisis put paid to the hedge fund illusion for a lot of investors. Much-vaunted downside protection appeared to be just that – a bloody illusion. Far too many funds got carried away in the boom years & somehow ended up believing ‘hedge fund’ meant being leveraged, not being hedged..!? Performance during the crisis was almost as horrendous as the indices, or even the average open/closed-end fund – which certainly wasn’t what most investors were expecting, or thought they were paying for…


Since then, hedge fund managers have generally lowered their sights, in terms of leverage & expected returns. This is all part of a pronounced trend towards institutionalization within the industry – with a far greater emphasis on pushing the firm & the low correlation/consistency of returns, rather than pitching the notion of a maverick investment genius swinging wildly for the fences. Additionally, the periodic zig-zag and risk-on risk-off nature of the markets in the past couple of years has proved difficult to manoeuvre, which has also tended to clip managers’ wings.
[The more exotic credit/mortgage funds being the pleasant exception in the past 2 years. All kudos to them, but it's quite obvious they've also enjoyed a spectacular rebound in what was a completely trashed asset class, and they were the primary beneficiaries of the scaling-back in Wall Street balance sheets, risk & prop. trading activities].


Of course, the industry has attempted to hang on to its 2 & 20 fee structure, despite the compression in expected & actual returns. Unfortunately, the realproblem for private investors (PIs) has always been more about the layers of fees they face: Realistically, most PIs access the sector via hedge funds of funds (HFoFs), and thereby incur two (even three) layers of fees. In the good old days, less vigilant investors (myself included) never even noticed – and who cared, as long as net returns continuing to rack up nicely each year. And investors were persuaded HFoF managers offered extra value as gatekeepers & master investors – they’d avoid the hedge fund duds & expertly guide investors’ funds into the industry’s hot hands instead. Such as Bernie Madoff & other less spectacular frauds… If you were a tad luckier, they didn’t lose your money – it just ended up frozen in gated funds!


Not surprisingly, private investors are much less enthused about hedge funds these days – the investment proposition’s viewed with far more caution, the liquidity profile of some funds remains uncertain, and poor returns are an unpleasant reminder of how large a fee bite was coming out of investors’ (gross) returns. However, there’s plenty of funds to consider – many of which don’t fit the classic HFoF profile – in fact, they may still offer an interesting (even compelling) investment opportunity. Let’s see what’s out there…

Alternative ETFs: There are quite a number of London/NY-listed hedge fund/alternative ETFs these days. In my opinion, they’re often opaque, have unattractive structures/strategies, and to date they certainly don’t appear to have delivered anything to distinguish themselves in terms of performance…

Fund of Funds: London has Alternative Investment Strategies (AIS:LN), Dexion Trading (DTL:LN), Dexion Absolute (DAB:LN), Thames River Multi Hedge (TRMA:LN) & Absolute Return Trust (ABR:LN). Switzerland has Absolute Invest (ABSI:SW), while Castle Alternative Invest (CAI:LN) & Altin (AIA:LN) have added a dual listing in London. Sweden has Havsfrun Investment (HAVB:SS). [NB: Many of these funds are now in wind-down mode. Underlying currency risk's generally in US dollar & only certain funds hedge that risk. Many London-listed funds also have other currency class shares, which generally means currency risk is hedged].


Then there’s the grand-daddy of the industry, Leveraged Capital Holdings, which was set-up in 1969! It also has two other sister funds that were started in the ’90s, European Capital Holdings & Asian Capital Holdings. All three funds offer subscriptions & redemptions, but are also apparently listed & traded on Euronext Amsterdam.

Distressed/Credit Funds: Covered here.

Activist Funds: Covered here (and this post may also prove interesting). Alpine Select (ALPN:SW) & Special Opportunities Fund (SPE:US) are further examples.

Single Manager Fund of Funds: These funds generally only charge a single layer of fees, and offer exposure to a single hedge fund manager’s range of funds/strategies. These funds are also somewhat neglected in the current market, but many of these managers/funds possess a notable distinction – they actually delivered positive returns (or at least avoided major losses) during the financial crisis! If you can reluctantly drag yourself away from the punch bowl, some of these funds might offer a suitable resting place. They include Bluecrest AllBlue Fund (BABS:LN), Bluecrest Blue Trend (BBTS:LN), BH Global (BHGG:LN), BH Macro (BHMG:LN), Boussard & Gavaudan Holding (BGHS:LN) & Luxonen (LUXO:SS) (in wind-down).


btw I’d encourage everybody to read ‘Hedge Fund Market Wizards’, if only for the interview with Michael Platt of Bluecrest Capital – it’s a marvelous introduction to how some funds actually approach their trading/investment & risk control. [OK, the interviews with Colm O'Shea of Comac Capital & Jamie Mai of Cornwall Capital are similarly awesome!]

Single Manager Funds: These are a more focused bet, and include some obvious stars of the hedge fund world, like Blackrock Hedge Selector (UK Emerging Companies) (BHUE:LN), Pacific Alliance Asia Opportunity Fund (PAX:LN), Africa Opportunity Fund (AOF:LN), Third Point Offshore Investors (TPOG:LN) & Greenlight Capital Re (GLRE:US).

Hedge Fund Seeding: Seeding young/small hedge funds has always been a compelling opportunity – returns can be significantly better, and for that funding commitment the seeder usually acquires a stake in the hedge fund management company for little or no cost. A lot of money piled into the strategy somewhat indiscriminately in the boom years, and now with banks reducing/eliminating their prop. trading activities, there’s been a huge resurgence of interest as traders migrate to the hedge fund world.
Offer investors a piece of **** junior resource stock & they’ll pile in, but this strategy’s apparently terrifying..?! Consequently, there’s never been a decent listed seeding vehicle. Alpha Strategic (APS:LN) provides a taste, but is far too small to have any real traction. However, as I noted earlier in the year, I’ve high hopes Tetragon Financial Group (TFG:NA) will ultimately devote some/all of its portfolio to an in-house/external seeding strategy – this is an exciting opportunity, and they’ve clearly got the firepower & the resources to achieve it.

Hedge Fund Managers: Of course, if seeding isn’t your cup of tea, plenty of well-established hedge fund & alternative asset managers have listed in the past several years. I may have slated the HFoF industry earlier, but its continued decline poses no threat to the overall growth rate, or asset-gathering ability, of the hedge fund industry. A majority of HFoF assets came from family offices & wealth management advisers anyway – and over the years these investors have (in increasing numbers) chosen to do their own due diligence & invest directly – a trend that’s now accelerating. However, the real prize for hedge funds is the (relatively untapped) trillions of dollars invested in pension funds – winning that prize is the primary reason for the increasing institutionalization of the industry.


Many of these retirement funds are under-funded, plus they have unrealistic return expectations to boot… They desperately need diversification & equity-like returns, but are equally desperately to avoid the associated volatility, which they obviously can’t afford – hedge funds represent the obvious solution. I wrote more on this topic last year in a series on alternative asset managers – the series focused primarily on my approach to asset management valuations, the level of balance sheet cash & investments in the sector, and a brief run-down of the managers themselves (inc. a number of hedge fund managers). See here, here, here & here.

Other Funds: Before we wrap up the category, it’s worth noting there’s many other excellent funds out there which aren’t quite hedge funds, but perhaps belong here – they often have a significant hedge fund portfolio allocation, and/or they take an eclectic/go-anywhere approach to investing, usually with a focus on achieving absolute returns. Good examples include Norvestia (NVABV:FH), First Opportunity Fund (FOFI:US), RIT Capital Partners (RCP:LN), British Empire Securities & General Trust (BTEM:LN), Lindsell Train Investment Trust (LTI:LN), Cayenne Trust (TCT:LN), Independent Investment Trust (IIT:LN), Leucadia National Corp (LUK:US), Establishment Investment Trust (EST:LN), Ruffer Investment Company (RICA:LN), Hansa Trust (HAN:LN), Personal Assets Trust (PNL:LN), Pico Holdings (PICO:US) & Livermore Investments Group (LIV:LN).


[Approx. half my hedge fund allocation was invested in an undisclosed low volatility/arbitrage hedge fund (which I've since sold - yes, to recycle into higher vol. investments, of course..!). The other half was/is invested in Livermore Investments Group (LIV:LN), which I last wrote about here & here. Since they've recently released their 2012 final results, let's revisit my analysis:


In 2012, Livermore increased their NAV by an incredible 53% to $0.87! The current GBP 32.5p share price now trades at a colossal 43% discount to the GBP 57.2p NAV. However, I'd estimate Livermore's NAV has improved further: Their current annual run-rate for interest, dividends & rent is $27.5 mio, offset by an approx. $9.0 mio in total annual admin. & interest expense. There's been a negligible impact from the change in value of listed holdings & FX rates since, so I reckon NAV's increased by about $7.3 mio to $180.2 mio. However, they've just executed their first share buyback of the year (for 3.5 mio shares), which cost $1.7 mio. This reduces my estimated NAV to $178.5 mio & a corresponding share count of 195.3 mio shares outstanding. This equates to a $0.914 & GBP 60.1p NAV per share.


Risk also appears to have reduced in the portfolio. The LTV ratio (inc. derivatives) on Wyler Park, their Swiss property investment, is still steep (at 72.5%) but is non-recourse. Other debt, net of available cash, has reduced significantly & now stands at only 5% of non-cash/property assets. Further write-downs were also recorded on the company's private equity(PE) assets - SRS Charminar has the potential to double from its reduced $10.1 mio valuation in the next 5 years, while the $13.4 mio portfolio of PE funds has probably reached the nadir of the J-curve at this point (funds were invested in 2008 & 2009).


Of course, the main driver of Livermore's performance is their (largest) portfolio allocation (of 42%+) to CLO residual equity tranches. I've written about CLOs before, here, and identified Tetragon Financial Group (TFG:NA) as the cheapest pure play. I didn't mention it before, but the main reason I limited my TFG holding (aside from residual equity's inherent leverage as an asset class) was because of my existing LIV exposure to CLOs. Sure, it's not a pure-play, but Livermore's current 46% discount to estimated NAV makes it a highly attractive CLO investment - in addition to being a compelling & eclectic hedge fund opportunity.


Then again, I must highlight the small matter of insider ownership - which is now around 86%! Some investors will never be persuaded to invest in something like that, and I admit it's somewhat limited the size of my own holding - but I think I make a good case here why this ultimately shouldn't be a huge cause for concern.


I continue to haircut my NAV estimate to reach my fair value price target. About 41% of Livermore's portfolio is now invested in PE funds & (leveraged) real estate. If I apply a 30% haircut to that portion, it would (roughly) imply a 12.5% discount for the entire portfolio. That's equivalent to $0.80 or a GBP 52.6p Fair Value per share – offering 62% Upside Potential vs. the current GBP 32.5p share price].

Event-Driven, Fixed Income & Cash (21%):


As I reduced my listed hedge fund holdings over the years, I didn’t reduce my appetite for low(er) volatility/correlation & alternative investments. My portfolio allocation’s generally migrated to event-driven, fixed income & cash as a suitable replacement. I actually group them together as they play a v much related function in my portfolio. To explain:

Cash: Quite honestly, I really don’t believe in cash, or see much of a role for it, at least in my portfolio! I also try to avoid home bias as much as possible, or any kind of benchmark-hugging. Couple that with (unfortunately!) Jim Cramer’s favourite phrase - ‘There’s always a bull market somewhere‘ – and I’m usually not stuck for investments & ideas, however unusual/contrarian they might have to be when regular markets are in bull mode. Therefore, any cash in my portfolio’s usually accidental & decidedly temporary.


Of course, I’m not a complete idiot..!? If too many markets and/or sectors are looking over-valued, or the macro/political outlook looks especially threatening, or I simply can’t sleep soundly at night, then I know I need to lighten up on my holdings right across the board. This is something that tends to wax & wane in its intensity, and adjusting cash levels accordingly might seem the obvious solution. But cash is dead money – I prefer a better substitute:


Event-Driven: This is a part of my portfolio I don’t write about so much – it can be difficult to keep posts timely & relevant when it comes to such investments, and returns may rely on technical analysis & good trade execution just as much as the quality of your fundamental analysis. The scale of my event-driven portfolio can significantly lower risk in my overall portfolio (or allow me to increase risk elsewhere in the portfolio), while still offering the potential for attractive returns.


The different categories of event-driven investments also allow me to ratchet risk that much higher or lower, if necessary. This is an important point -I believe some event-driven categories substantially reduce market risk (in most instances), but don’t necessarily reduce investment risk. That lack of correlation is reassuring, but obviously I demand higher potential returns to compensate for the higher investment risk. My series on catalysts walks through six categories of event-driven investments (by increasing level of risk) – the series begins here & ends here, and I also wrote two summary posts this year (here & here). Most of my event-driven investments are smaller & undisclosed – but my largest holding actually was/is Argo Group (ARGO:LN).

Fixed Income: Here’s another asset category I pretty much don’t believe in, for reasons far too obvious to elucidate. [Except to say I'm constantly perplexed at the idea bonds supposedly lower risk when, in the final analysis, they potentially present such a bloody asymmetric risk..!?] With event-driven investments playing the risk-adjustment role in my portfolio, I’m only interested in bonds as an investment if they present equity-like risk:reward. Unfortunately, that generally means we’re talking about distressed debt investing, a discipline which requires far more skill, experience & resources than most people have to spare – including me.
However, on that rare occasion, I do come across a misunderstood asset (category) that offers a beaten-down fixed income opportunity. Raven Russia (RUSP:LN) was a holding (which I’ve now divested) I wrote about quite recently to illustrate my approach to fixed income. However, since my original pie-chart last year, I’ve actually re-allocated a significant portion of my event-driven portfolio into my largest holding (& largest fixed income investment ever):

Alternative Asset Opportunities (TLI:LN)


TLI has assembled a portfolio of life insurance policies – which I consider to be essentially equivalent to a portfolio of fixed income investments with a somewhat indeterminate (but far higher) average coupon & maturity date… You know what, have a read of the post – I think you’ll enjoy it!
OK, we’re done, and now there’s only Emerging & Frontier Markets left to cover – maybe I’ll actually have this series completed within a year!?