Research shows that assets such as hedge funds, private equity, and derivatives are filtering down from the institutional to the retail space, with growing numbers of high net worth individuals seeing alternative strategies as an important part of their asset allocation.
A recent survey by the Economist Intelligence Unit (EIU) on behalf of Barclays Wealth Insights shows that the world's wealthiest individuals are planning to put more money into alternative assets, including hedge funds and private equity, over the next three years.
The survey questioned 790 mass affluent, high net worth, and ultra high net worth individuals from around the world between January and September 2007, supplemented by in-depth interviews with wealth experts.
An Appetite for Alternatives
The survey compares the assets in which respondents had invested over the past three years with their planned investment over the next three.
Two trends stand out. First, investors are planning to move away from equities. Second, many high net worth individuals would like to increase their exposure to less traditional asset classes, such as hedge funds, private equity, structured products, and derivatives. Taken together, these results suggest that wealthy investors would prefer to reduce their exposure to market returns, which depend on general directional movements in financial markets, and move towards a more stable return profile.
The shift away from equities is clear. While 48 per cent of respondents say that they planned to invest in stocks over the next three years, this is much lower than the 64 per cent who had invested in this asset class in the previous three years. The same finding is corroborated by other research. For example, the members of TIG ER 21, a New York-based high net worth group with more than US$8 billion in total assets, reduced their equity investments from 37 per cent of their portfolio in 2005 to 30 per cent in early 2007.
By contrast, the assets in which respondents expect to increase their investments are private equity, hedge funds, derivatives, structured products, and commodities. While just 11 per cent of respondents had invested in private equity over the last three years, 15 per cent were planning to do so in the next three years.
Another notable finding was that the wealthier the individual, the more likely they are to use alternative strategies. Respondents with assets in excess of US$1 million are more likely to have invested in hedge funds, derivatives, and private equity in the past three years than those with assets below that threshold. Respondents with assets over US$3 million were even more likely to have invested in these vehicles. One reason for this is structural - most of these investments carry a minimum investment that is sufficiently high to restrict them to the top wealth brackets.
Asia and the Middle East
Didier von Daeniken, Head of Barclays Wealth in Asia, says that Asia has very shrewd investors with strong appetites for many of the more exotic investment vehicles, such as structured products. "Private banks in Asia need to ensure that bankers in the region have a good understanding of the impact these instruments can have on an investment portfolio," says Mr. von Daeniken.
In the Middle East, EIU research has also revealed a growing appetite for structured products, derivatives, and private equity among more sophisticated investors. Particularly popular are products that are Sharia-compliant. The region has seen huge development in the Islamic finance sector in recent years, and this is rapidly filtering through to the asset management arena, where considerable product development is now taking place.
Desperately Seeking Diversification
The search for diversification is a key factor in the popularity of these assets. Adding some private equity, hedge fund, or derivative exposure to a portfolio can help to reduce overall levels of risk by spreading it across a wider range of assets.
More and more wealthy individuals are thinking in terms of absolute return investments such as hedge funds. Along with derivatives and structured financial products, these can be used to manage risk, reduce volatility, and stabilise results.
Despite the increase in popularity of alternative asset classes, there is a large knowledge gap. Only around one third of respondents questioned for the survey said that they understood how alternative strategies worked, with investors feeling less confident about alternatives than any other area surveyed.
Just 27 per cent of respondents said they understood how hedge funds operated, while only 36 per cent said they were confident about investing in private equity and venture capital. With private equity and hedge funds attracting growing interest from sophisticated investors, it appears that in many cases, knowledge has not yet caught up with appetite.
Barbara-Ann King, Head of Alternative Product, Barclays Wealth