Wealth planning has to check the alternatives

Alternative investment is a tool, not the entire toolkit. Use it in isolation and you take a risk. Use it to balance a portfolio and you control risk.

These alternative fundamentals underpin the approach to this fast-growing class at Barnard Jacobs Mellet Private Client Services (BJM PCS), a wealth planner and asset manager with the job of preserving and growing the assets of thousands of high net worth individuals.

When your task is to enhance wealth rather than place 'bets' with it, your prime focus is on the ability of alternative investment to complement an overall wealth plan, says Erol Zeki, head of alternative investments at BJM Asset Management.

He explains: "South Africa's hedge fund industry is relatively small, but still offers a broad range of products. A client is therefore inclined to ask 'Which is the right one for me?'

"However, the first question is more fundamental Do I need alternative investment and how does it fit into my overall portfolio?

"A hedge fund is a partial solution, not the be-all and end-all of investment planning."

BJM PCS prefers to assess needs and an investor's risk-return profile and then examine all portfolio elements. 'Alternatives' are then considered as an ingredient in the mix.

When it comes to specific funds, three questions are pertinent: What is the track record of the manager, what is the investments risk-return profile and what parameters govern the manager's decision-making.

"Pay special attention to the amount of gearing or leverage and the size of the position a manager can take in a specific security," says Zeki.

Hedge funds use various techniques to balance risk, but investors should not assume that balance means perfect equilibrium of upside and downside.

Zeki notes: "Some may think that a fund taking 'long' and 'short' positions has negated risk. This is not true. A directional bias will usually be evident. If the bias is tilted strongly in a particular direction, then risk may have been eased, not erased."

This explains why the professional help of a seasoned wealth planner is often required to assess the risk characteristics of specific products relative to overall portfolio exposure. Net risk reduction can then be achieved.

Zeki points out: "The behaviour of many hedge funds is uncorrelated to the behaviour of mainstream markets. Therefore, it is possible to control overall portfolio risk by taking a position in alternative investments, even in an alternative product carrying relatively high risk, as long as there is low correlation to other elements in the mix."

Using hedge fund products to recalibrate portfolio risk can be a key requirement at the current stage in the equity market cycle. Three years of high equity growth can easily skew portfolio weightings. A 60-40 bias in favour of equities could become an 80-20 bias purely as a result of market growth.

Even when the 'house view' remains solidly in favour of equities, such a strong bias may be inappropriate. A re-weighting exercise will then be carried out sometimes prompting a recommendation that alternative investments be included in a revised mix.

Says Zeki: "Alternative investment should not be a chance to place a bet on superior returns. Its a chance to better align your overall portfolio with your overall objectives. Thats the alternative that works best for prudent wealth planners."