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August 01, 2008 at 04:00 AM
Despite the recent tumult in the hedge fund world with the collapse of Bear Stearns’s two hedge funds and the subsequent arrest of its two managers a month ago, money continues to pour into hedge funds. According to PerTrac Financial Solutions’s 2007 Hedge Fund Database Study, assets under management by single-manager funds topped $2 trillion last year and $980 billion flowed through funds of hedge funds.
Indeed, the current global credit and liquidity crises, along with low bond yields and economic instability, are forcing more and more advisors to turn to all sorts of alternative investments to diversify their clients’ portfolios and find uncorrelated assets, says Doug Beck, managing director and head of product management at DWS Investments, formerly DWS Scudder. Mutual funds that use hedging strategies are increasingly in vogue as well. DWS started its DWS Alternative Asset Allocation Plus Fund in July 2007, and the fund has accumulated a whopping $400 million in assets in less than a year.
I spoke with Beck in late June about the use of alternative investments.
Can you elaborate on how the current market is fueling the use of alternatives? We’re definitely talking about alternatives broadly cast, so strategies that have low correlation to the traditional asset classes that are the building blocks of portfolios like U.S. large-cap equities and investment-grade fixed income and the like. So satellite strategies that have lower correlations also include international equities but going out further on the fringe, emerging markets, emerging markets debt, and even further out into commodities, precious metals, inflation-protected securities, and, finally, last but not least, hedge-type strategies like market neutral funds. So the bottom line of what those all have in common, as I started with international equities and expanded out to market-neutral products, is they have increasingly lower correlation to the building blocks of what would be a typical asset allocation.
The current environment has exacerbated that and made the challenge even more of an imperative given the fact that when you get into crisis-type situations, not just the current but crises of the past, your correlations for the most liquid asset classes tend to spike up for periods of time. That doesn’t just mean that U.S. large cap S&P 500, for example, relative to let’s say European markets, but it also means, in some instances, equities relative to fixed income, which you would typically not expect.
How are inflation worries affecting the use of alternatives? That’s occurring now, correct? Yes. This crisis is different in and of itself in that initially we had a credit issue that sparked a liquidity crisis and simultaneous to that we have a spike in commodities and that’s fueling certain inflationary fires. Basically what’s unique is that we’ve been in a period for almost the past 25 years up until very recently where it made sense to trade out of real assets for paper assets. Now, what I’d say is instead of real for paper, we’re now potentially going back to paper for real to some degree.
Explain. Paper assets being traditional equities, traditional fixed income. Commodities have not been in vogue until quite recently, and that’s been because we’ve been in a deflationary environment. People forget about the time where you had, up through the late 1970s, a President on television wearing a cardigan sweater saying everybody should wear an extra sweater and lower the heat in their house. Then we entered the ’80s, ’90s, and early 2000s where inflation was kept under control, there was a lot of outsourcing of labor, commodities were still plentiful, and now we’ve had several different triggers–emerging market growth is shooting up, China, India–and labor isn’t as cheap anymore. We have everything from climate change impacting rainfall in Chile so the Chilean copper mines that are driven by hydroelectric power don’t have power. You have dislocation in a lot of these commodities markets, and that’s fueling a reallocation from institutions and individual investors, many of whom, until recently, didn’t have any significant allocation to what we call real assets, or real assets in their portfolios or equities that benefit from real asset price inflation.
