KIC, Pru CIOs warn against over-reliance on alts
Asset owners’ surging demand for alternatives assets have caused asset costs to soar and left them at risk of suffering from potential corrections. To mitigate these pricing pitfalls, investors need to focus on spreading their investment risk across public and private markets investments, said chief investment officers at AsianInvestor’s 14th Asian Investment Summit in Hong Kong last week.
The chief deliverers of this warning were Benjamin Rudd, CIO at Prudential Hong Kong, and Tae Park, deputy CIO at the sovereign wealth fund Korea Investment Corporation (KIC).
“At the moment, I believe the private markets are overpriced,” Park said, noting how Korean institutional investors are flocking into alternatives “in droves”.
This has certainly been the case, with many Korean pension funds possessing alternative positions of 40% or more of their investment portfolios as they seek the longer term and supposedly more certain investment returns offered by such assets.
Park said such voracity for assets usually indicates the peak of an investment cycle, or maybe even a bubble. At the very least it leaves investors in danger of seeking exposure in industries or sectors without sufficient consideration for the risks involved.
“A lot of these insurance and pension companies are getting into private markets because they supposedly exhibit low volatility, because they don’t have to mark them down in a market downturn. So I think they are getting into alternatives exactly for the wrong reason,” Park said.
He referred to his basic finance training, noting that if alternatives exhibit low value at risk (Var) they should also provide a lower expected return.
“Private equity supposedly has a low Var and a higher return than public markets, which doesn’t make sense. So again: It is a sign that the market is near the peak of the cycle,” Park said.
Korea Investment Corporation CIO Kang Shin-woo previously addresse the issue of valuation risk among alternatives. He said the sovereign wealth fund seeks to mitigate it by seeking to invest into assets directly, to gain more control.
Prudential’s Rudd agreed that some caution must be made for the alternatives asset class. His concern stemmed from the surge of capital entering the asset classes, which are traditionally defined as encompassing private equity, private debt, real estate and hedge funds.
Rudd raised a concern that the so-called liquidity premium of alternative assets will be diminished by too much capital inflows. That means asset owners have to be even more disciplined in their approach.
“An awful lot of money is chasing an awful lot of deals. Again, a part of the problem is that a lot of asset owners have historically had the assumptions that private equity delivered equity plus 300 basis points. Should that happen to not be the case, you will find out sort of five years too late,” Rudd said.
To avoid this, Prudential seeks to have a more diversified approach across alternatives asset groups, rather than traditional large allocations into just one area, the Hong Kong CIO said.
AVOID SILO APPROACH
Park and Rudd agreed that alternatives assets should not be viewed completely separately from public markets – opposite to the traditional view that such investments are not correlated to stock or bond valuations.
Instead, the men said asset owners should strategically seek to use both public and private allocations to get exposure to certain areas such as geographies or industries.
Alternatives, Park pointed out, are a very diversified group of underlying investments. He used the example of private equity, where energy companies have a very different profile than tech or healthcare companies.
“You cannot just log them [private equity funds] together as alternatives. You have to look at the different industries and sectors as a part of the total portfolio; which factors and sectors you have most exposure to,” Park said.
“Then you try to diversify across these factors, regardless whether it is private or public. That is the approach that we are trying to implement as we speak.”
Rudd picked up on Park’s use of the energy sector, noting that Prudential would consider whether it most wanted to gain public or private exposure to such an industry, rather than letting its external public and private fund managers approach the sector independently, and potentially leave it with more exposure than it wanted.
“Private and public markets are separate but you have to understand the interlinkages between them; you can’t just think of them completely separately. Otherwise you do run the risk of actually taking the same risk in different parts of your portfolio without really understanding them,” Rudd said.
In addition, the two men discussed whether it was necessary for asset owners to take a more assertive approach when allocating mandates to external managers.