Alternative Investment Classes

Updated: 01/07/2007 09:22
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There is no doubt that conventional strategies of the diversification of an investment portfolio lose effectiveness. Many markets develop by the increasing integration ever more in lockstep. Therefore, specialists advise to add so-called alternative investment classes (for example, Hedge funds, ex-pit participation (private Equity) or inflation-indexed bond issues) to a traditional depot.

Already since the statement "not to put all eggs into a basket" belongs to the basic rules of a careful investment strategy, we can say that there are two investment possibilities, namely, on the one hand, we have different investment classes such as shares, bond issues, and cash and gold, on the other hand, there are different countries, industries and currencies.

But newer studies demonstrate that conventional diversification strategies do not work any longer as well as in former times (first of all, they do not work in a economic slump of stock markets).

American elite universities, which want to invest their billions-worth foundation capital as profitably as possible, pulled consequences already. The University of Yale invests, for example, only 38 per cent of its billion-assets into traditional investment classes such as shares and bond issues and 62 per cent into alternative instruments (among them Hedge funds, immovable property and raw materials). This is one of the reasons for last rapid growth of Hedge funds and private Equity funds.

According to Iris Uhlman's study of the executive board of the investment analysts' Association "German CFA Society", the global synchronisation of the share and bond issues markets rises during the cyclical downturn and also during bad stock exchange phases strongly. This process is strong at the euro-area, but recently Iris Uhlman also reported about the global increase of the correlations in addition.

Moreover, the capital markets of the monetary union are ever more closely interlocked. Thus according to Uhlman, the effect of a spread of traditional portfolios declines in several countries exactly if the risk reduction is particularly important by diversification.

Instead of diversifying the portfolio to countries, Uhlman recommends therefore to invest into alternative investment classes. According to her studies, for example, gold, immovable property and risk capital are suited to the diversification's shares and bond issues as a result of poor correlations, but however immovable property shares should be ignored.

Investors should take not only government bond issues but also bonds and mortgage collateralised loans in the depot for the dispersion of a bond issues portfolio, furthermore also inflation-indexed and high interest loans.

Uhlman mentions works of art and assets-secured loans (ASL) among other things as alternatives of shares. Moreover, the analyst, who is the business guide of the Call Capital & Finance GmbH in Berlin, points out that also Hedge funds and "Managed Futures" as alternatives of shares (thus professionally administered portfolios of forward contracts) might be suitable for the diversification. However, she guesses that these young investment classes in Europe still have little experience.

Uhlman points out that even though there is general opinion about alternative investment classes that they would usually have above-average return yields, but also they show poorer liquidity than traditional investments. A disposition of these assets can prove to be difficult or economic lossy in crisis situations. In this respect, alternative assets are suitable particularly for the investors oriented on a long-term basis.

Furthermore, as a result of alternative investments the synchronisation between the American and the continental-European stock markets is particularly strong within a stock exchange downturn. According to Goldman Sachs's study, it averages that European shares had followed the pricing trend in America to 70 per cent.

During an exchange boom in America the correlation amounts to only 28 per cent however. The Japanese stock market does not follow therefore the Wall Street so closely in the tow line because during an exchange downturn the correlation amounts to 40 per cent, within the economic boom it amounts to 11 per cent. So this is practically uncorrelated.

According to Goldman Sachs, dependence is strongest if the Wall Street's courses fall more than 8 per cent within one month because the correlation of European shares amounts to 72 per cent but all the same the Japanese shares amounts to 50 per cent. These correlations amount to 69 and/or 40 per cent by exchange loss between 1 and 3 per cent in America.

Depending on the economic cycle's phase, the Goldman Sachs analysts come however to another result than Uhlman, namely, according to them the foreign markets are hooked on the American markets in the strongest way if the world capacities are fully loaded but the demand increases however further. Thus, this process does not work in the cyclical downturn but in the economic boom phase.

The investment bank explains this statement that stock exchange development in some countries can be determined by individual factors if there is an under-utilization of the capacities. However, if there were global capacity bottlenecks the general estimate of the further world economic prospects would become the relevant regulation reason for the further pricing trend at all stock exchanges.


About the author

Nicole Berger has over seven years experience writing and editing for online and print media. She has held various editor and associate editor positions in some of forefront independent media publications. A consistently dependable team player, I thrive in a high-pressure environment, enjoy the challenges of meeting deadlines and managing a team, and am comfortable researching, writing and editing on a wide range of topics.
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