Maggie Tsui, deputy head of investment services for BNP Paribas Wealth Management in Asia, talks to Hubbis about some of the ways that investors can tackle choppy and uncertain markets via the use of income-enhancing and alternative investment strategies.

Date: Mar 2, 2012

Tags: Income, Dividends, Equities, Structured products, Fixed income, Alternative investment, Hedge funds, Fees, Asset allocation, Portfolio construction, Suitability

After the 2008 financial tsunami and the recent turmoil from the Eurozone crisis, global interest rates remain persistently low. With the confirmation from the US Federal Reserve that interest rates will be kept low at least until 2014, returns of cash portfolio on major currencies will stay close to zero for a prolonged period of time.

There is no quick or easy way to enhance portfolio returns. It largely depends on investors’ investment behavior and the types and level of risks they are willing to take.

How can investors most effectively generate income for their portfolios?

One way is through direct investment into high-dividend stocks. This is a way to get better returns as compared with holding cash.

There are various selection decisions involved with this. Utility companies with high levels of cash and good records of dividend payments are a favourable choice, as are companies with sound and good potential growth.

Direct investment into equity markets is perhaps the best way amongst all options, although certainly the returns will be subject to market volatility, as high-dividend stocks also fluctuate together with the direction of the market, despite the low correlation.

What opportunities are there in the fixed income space?

Fixed income investment is traditionally considered a good instrument to generate income.

As a general rule, with the low yields on nearly all government bonds, it does not seem to be a favourable investment option in terms of value and risk.

Furthermore, we see value on some Asian credits which can offer attractive yields. Instead of investing in a single credit, investors may consider an Asian bond fund, which provides diversification in terms of risk.

What role can structured products play in enhancing yields?

Instead of staying reactive, investors can reduce their equity exposure on the recent rally and park their cash into short-dated equity-linked instruments.

This does not increase the total equity risk while the return on the portfolio will be enhanced.

Sophisticated clients who are willing to take on more risk may even employ a twin-win strategy on structured products linked to commodities like oil or gold. A twin-win structure will allow investors to get extra returns and simultaneously enjoy early-termination opportunities upon certain conditions, while the underlying risk is when the spot price moves against the structure.

With traditional asset classes suffering from the ongoing choppiness of markets, what potential do alternatives present clients with in terms of finding the kind of returns they want?

As we all know, alternative investments offer diversification, de-correlation and an improvement of a portfolio’s risk return profile. These are more suitable for seasoned clients who prefer stability with low volatility and a reasonable level of liquidity.

What are some of the current opportunities in Asia in alternatives?

Apart from traditional multi-strategy, multi-manager fund of hedge funds, there are UCITS-compliant single-strategy, single-manager hedge funds which offer more spice in terms of returns, with very good liquidity on a daily or weekly basis.

In addition to delivering absolute returns, Asian clients prefer hedge funds as one of the alternative investments managed by well-known managers with good liquidity. We believe the newly-developed UCITS hedge funds could fill that hole.

How is the way investors are viewing and using different types of alternatives evolving?

After the financial crisis in 2008, clients have definitely put more emphasis on risk management. For most of them, they mainly rely on us to recommend funds on which we have conducted a large amount of due diligence work.

On the other hand, UCITS hedge funds benefit from operating under a well-defined set of risk constraints, so are often perceived as a less risky, toned-down version of their offshore cousins.  However, single manager business risk remains.

What trends are there in fees?

Fees are coming down in the hedge fund industry, too. More and more funds of hedge funds are charging a flat management fee only, while UCITS hedge funds typically have fees lower than their offshore version.

What do investors need to do ensure appropriate suitability?

As advisers, we properly match clients’ risk profiles with our recommendations in all cases. Our internal risk-scoring system takes into account the funds’ expected volatility, degree of diversification and liquidity. More importantly, clients’ investment decisions have to be looked at from a portfolio point of view, rather than on a stand-alone basis.

What trends do you expect to see in the alternatives space going forward?

In recent years the whole industry has been facing performance challenges but hedge funds as a whole have reached all-time high in assets under management.

In terms of industry development, we are seeing an increasing trend of bi-polarisation. In short, bigger and established players have been playing an active role in industry consolidation and commanding a larger piece of the pie, while smaller firms are struggling to find their niche.

Meanwhile, funds of hedge funds are shrinking due to poor performance and the aftermath of the Madoff scandal. They have to work extra hard to demonstrate their value-add.

Traditionally, the alternative asset class has been more of a portfolio diversifier than an anchor for most clients. We don't think that will change any time soon, especially when clients value liquidity more and more. Indeed, we often find they are competing with traditional asset classes for clients’ attention and risk budgets.

Our challenge is to re-educate our clients on the merits of having alternatives as a meaningful part of their diversified portfolios.