I recently read some interesting reports about global fund industry and investments around the world. There is a clear trend towards significant consolidation in the world of investment funds, especially the hedge-fund industry.
The underlying liquidity is very difficult for funds. For example, the global hedge-fund industry lost $ 64 billion of assets in November. Market declines contributed to $18 billion in net losses, while investor redemptions made up $46 billion. According to hedge fund surveys, hedge-fund assets shrank by $110 billion to $1.65 trillion in October.
Hedge-fund industry assets once peaked at $1.9 trillion in June. Investment losses and withdrawals may shrink that amount by 45 percent by the end of this year.
Distressed selling and the rollback of debt-funded investments continued to pull down funds as the credit crisis put the U.S., Europe and Japan into the first simultaneous recession since World War II.
Moreover, the important lesson that we learn from the demise of hedge funds is that the attractiveness of spreading investment eggs in many baskets is losing magic, at least in the short term, as strengthening correlations of different asset classes are aggravating losses on a diversified portfolio.
During the credit boom of 2002-early 2007, investors were encouraged to diversify their traditional equity-bond portfolio, spread risks and seek extra returns by buying commodities, hedge funds, real estate which were seen as having almost zero correlation with traditional stocks and bonds.
However, since the credit crisis began in August 2007, these alternatives fell in lockstep with, or sometimes faster than, equities, driving volatility higher and amplifying losses of a risky portfolio.
A diversified approach worked like a charm until October last year. But diversification failed in 2008. Some of alternative assets went through bubbles and precisely these bubbles got punished. Assets that are overpriced do not give diversification.
Some experts’ analysis show returns to eight-asset class portfolio -- comprising of stocks, bonds, emerging market stocks and bonds, real estate, commodities, hedge funds and managed futures -- lost 29.1 percent since October 2007.
This compares with a loss of 26.3 percent in a simple equity-bond portfolio. And adding in fancier asset classes such as infrastructure, the 12-asset class portfolio lost an even deeper 43 percent in the roughly same period.
Until the last three months it used to be said that diversification is the only free lunch in the market but that free lunch seems to have gone away.
Some analysts say the very unique nature of the deleveraging this year has resulted in all risk assets falling at the same time. We are under stress and the correlation is going up.
However, undervaluation of a diversified portfolio is not related to the view that diversification is bad. Valuation on a diversified portfolio has gone down but that creates opportunities. Investors may not want to seek out new and seemingly uncorrelated asset classes to diversify their portfolio, but they should consider mixing traditional and alternative assets in the right proportions.
One investment expert interestingly said alternative investment has entered the main stream...alternative is never going to be alternative again.
By Chodechai Suwanaporn email: [email protected]
Source: www.fpo.go.th