risks of the emerging markets sector as a whole. This is potentially a reason why this asset class is under-represented in many portfolios - investors are seemingly reluctant to accept that a standard approach to risk management through portfolio diversification is sufficient to mitigate the overall level of risk associated with the EMD asset class. However, this view is not borne out by trading patterns - improvements to monetary policy and other structural reforms have seen local debt volatility fall significantly in recent times. Moreover, EMD has outperformed most asset classes over the past decade - not just in absolute terms, but also on a risk- adjusted basis. Distressed debt can be defined as being the corporate bonds of companies that have either filed for bankruptcy or appear likely to do so in the near future. The traditional investment approach involves becoming a major creditor in the first instance by snapping up the bonds of the 'target' company at a fraction of its paper value. This provides the element of control required to 'call most of the shots' during corporate restructure or liquidation. In terms of security subordination, the ownership of corporate bonds confers priority over shareholders in terms of the right to reimbursement. Consequently, the prospect of incurring a total loss of injected capital is remote, even where the business concerned succumbs to outright failure. Indeed, the well-publicised demise of Enron in 2001 and WorldCom a year later helped to provide investors of distressed debt with staggering returns approaching 50% in one calendar year. However, since then a lack of large bankruptcies has meant that the most widely-quoted indices of distressed debt have offered comparatively lean returns. Nevertheless, not all distressed debt strategies are contingent on the existence of high-profile bankruptcies in order to achieve attractive investment returns. The conventional approach is often referred to as 'control-oriented' and is based on the premise of achieving spectacular results from a small number of investments within a concentrated portfolio. As a result, they can be somewhat hit or miss in nature. Conversely, 'credit-intensive' distressed strategies do not seek all-or-nothing performance and are based on the pursuit of liquid and diversified 'minority' positions which are taken across the pre-default ('stressed') and post-default ('distressed') spectrum. This makes it possible to achieve recurring, incremental returns which are noteworthy for their consistency rather than their fluctuating nature. Private equity Private equity refers to medium to long- term finance provided to a company that is not quoted on a stock exchange in return for an equity stake in the same potentially high-growth business. The funds that a company raises through private equity can be used to develop new products and technologies, to expand working capital, to make acquisitions, or simply to strengthen the corporate balance sheet. Many institutional investors have been deterred by the fee scales involved. However, it has always been the case that providers of what is seen to be an extremely specialised proposition have been able to demand top dollar for their services. It is only when competition becomes more rigorous, and the overall reach of the industry concerned expands markedly, that the tag of exclusivity is shed and the profitability of running such a business declines from supra- normal levels. Conversely though, lower fees aren't necessarily the panacea, it is attractive net returns that the clients value. So, while lower fees are a good thing, this should not come at the expense of performance. There are some structural issues which dictate that trustees of charities need to take a measured approach to investment in private equity, which itself means that it can take time to find the right investment. In addition, the assets are typically locked away for at least three to five years and this lack of liquidity needs to be compensated for to ensure that the overall investment objectives are not compromised. Nevertheless, the diversification benefits and superior return potential mean that opportunities to invest in private equity require serious consid- eration. Having said that, it would be wrong to imply that private equity constitutes an appropriate investment media for each and every charity - much will depend upon the size, funding status and investment objective. There are potential pitfalls associated with each of the above mentioned asset classes for the uninitiated, but there are ways in which the prospective benefits of these alternative forms of investment can be harnessed in a very productive manner. It is possible for charities to gain access to carefully constructed portfolios covering each of these asset classes, which could, individually and collectively, offer a very attractive risk-adjusted return expectation. The key is to ensure that the appropriate advice is sought and that the trustees are able to gain a full under- standing of the dynamics to ensure that any such proposition fits in with their overall investment policy. HSBC Global Asset Management has a dedicated team of charity investment professionals serving over 400 voluntary sector clients. Factsheet Factsheet: Alternative Investments Factsheet: Alternative Investments Sponsored by Sponsored by Factsheet Charitytimes Alternative Investments Factsheet Charitytimes Alternative Investments Factsheet I nstitutional investors have long been reluctant to embrace new develop- ments and innovations in investment strategies. Indeed, UK institutions lag way behind those of other major countries in terms of their participation in financial products such as hedge funds. Yet much of the research that has been conducted into the potential benefits that occupational pension schemes could derive from the use of alternative invest- ments could equally be applied to charities. Contrary to popular thinking, many hedge funds operate with an objective of minimising the prospect of sustaining a capital loss, regardless of broader market conditions. Such strategies often focus on arbitrage opportunities, or seeking to exploit research findings at either the corporate or macroeconomic level by establishing 'covered' positions, which limit the associated risk. Fee structures are gradually being scaled back and we are slowly moving towards a culture where institutional investors contemplating a sizeable invest- ment should be able to negotiate a compet- itive fee based on their funding level. Meanwhile, considerable efforts are being undertaken to improve transparency, with more and more UK hedge funds planning to adopt the practice of many of their international counterparts by appointing a chief investment officer. As well as being lowly correlated with other investment vehicles and assets, hedge funds have the ability to deliver positive returns in rising and falling markets, which makes them a great diversifier and an attractive asset in absolute terms. However, the problem for charities is the difficulties that the trustees face in trying to comprehend precisely what the risk/reward trade-offs are. Nevertheless, many investment houses are now offering fund-of-hedge-fund products which seek to blend hedge fund strategies to provide potentially superior investment returns with greatly diminished risk. Emerging market debt For many years, investors have been searching beyond the familiar frontiers of domestic equities and bonds for asset classes that might improve the risk and return characteristics of their portfolios. Until recently, though, few had been prepared to diversify their fixed-interest exposure to include holdings in emerging market debt (EMD). However, increasing allocations in recent times are signs that the appetite for EMD is beginning to change. This is not surprising as the constituent countries of the emerging markets universe comprise 85% of the world's population, 76% of the world's land and two thirds of the world's natural resources. Nevertheless, the growth of EMD as an asset class remains in its infancy. The common perception is that the major risk associated with an EMD portfolio is volatility - the market price fluctuations that encapsulate the foreign exchange, interest-rate, political and economic An investment alternative for charities HSBC Global Asset Management looks at the opportunities offered by alternative investments that charities should be considering www.charitytimes.com www.charitytimes.com For more information or an informal chat about our services, please contact Andrew Fletcher, Head of Charities on 020 7024 0306† / andrew.fletcher @hsbc.com or visit www.assetmanagement.hsbc.com/ukcharities † Calls may be monitored and/or recorded for security and service improvement purposes.