If the draft Capital Markets Regulations 2021 get the nod, institutional investors would be free to add so-called “alternative” investments to their portfolios.
These alternatives — debt, private equity, infrastructure projects, SME and hedge-fund strategies — are supposed to provide the diversification that good old stocks and bonds can’t.
Part of the proposals says each alternative investment fund (AIF) should have assets of at least Sh10 million with no less than Sh1 million contributed per investor.
Furthermore, no AIF should have more than 20 investors onboard and the manager shall have a continuing interest in the fund of not less than two and half percent or Sh1 million.
Not considered under this group are family trusts, employee stock ownership plans (ESOPs), pension funds and holding companies.
But just like any other asset class, I am less impressed by complexity, structure or need to find space in a portfolio. I simply want to know: can these funds actually “beat the market” or are they just another gimmick looking to capitalise on a concept that is incapable of delivering the actual goods for investors?
And here’s where my concerns begin.
First off, forget what they told you about uncorrelation; many “alternative” investments have turned out to be highly correlated with traditional assets, in some cases moving almost in lockstep. I’ll touch on this on another day.
The few that don’t, the returns don’t even justify the risk and outperformance is inconsistent.
From what’s billed to be AIF’s biggest selling point, this is terribly disappointing.
But just to stay on the point of risk — one area that’s rarely highlighted by the sponsors of AIFs are the “gate” provisions.
Most AIF funds invest mainly in illiquid securities (including restricted, distressed, unlisted shares and/or privately placed securities) which means exposure to liquidity mismatch.
When stuff goes wrong (as it often does), these funds are known to activate “gate” clauses which effectively slam brakes to redemption requests. And it’s obvious why this aspect does not get highlighted — it’s their secret weapon.
But that’s the reason AIFs are almost exclusively sold to professional investors who understand the fine print? That’s true, but who said “professional” is synonymous with “prudent”? So what’s your point? It's difficult to beat traditional asset classes on the issue of liquidity.
Another underestimated risk is valuation. To put it bluntly, there can be no assurance that the AIFs valuation will accurately reflect the value that will be realised by the fund upon the eventual disposition of such investment.
This simply means investors risk holding fund interests that potentially could be miles off from their “true” disposition value. Nothing can cure this, it is just how it is — valuation of illiquid investments is complex and uncertain.
Something extra to think about is the incentives. Fees charged are often based on both realised as well as unrealised appreciation. This fee may be greater than if it were based only on realised gains.
So, are these invitation-only risky alternatives really special in any way? No, just like other asset classes, they disappoint - their risk-adjusted returns are often volatile and often fail to “beat the market”, they suffer from liquidity challenges and misalignment of investor-manager interests is rife.
In short, AIFs are simply another address to park your money.
The writer is managing director, Canaan Capital
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