High Net Worth Clients Turn to Absolute Returns and Diversity
Absolute Return, a relatively new concept for many investors, is defined as "the measure of the appreciation or depreciation stocks or mutual funds face over time. The result is always expressed as a percentage." Ideally, absolute return products generate positive returns, whether the market is up or down.
For instance, if an investment has increased 10% over the past year, holders of that security have earned an absolute return of 10% over that period.
High and ultra high net worth investors define absolute return based on their belief they will receive a positive return on their investment regardless of the identity of the underlying asset and regardless of the condition of the market. Theoretically and, hopefully, in reality, portfolios structured on absolute return products are up when the market is up and down when the market is down, unlike many traditional discretionary mutual fund portfolios. If the portfolios are up more than the index or down less than the index, their benchmark, they are doing a good job.
Some professionals believe that absolute return has become a key objective of high net worth clients. At the end of the day, if individual clients can produce money, it is his/her own money and, therefore, looks for absolute returns. High and ultra high net worth individuals looking for absolute returns realize that looking at alternative asset classes is necessary for at least three reasons:
1. They need investment diversification.
2. As markets become more sophisticated and volatile, having instruments that hedge, even in a downturn, are useful for overall portfolio rates of return.
3. They want wealth managers to select and recommend appropriate investment vehicles as they, as high net worth clients, demand more selections of alternative asset classes.
While some investment managers don't specifically term their products as absolute return vehicles, they do tell their clients that they try to find consistent returns on a year to year basis. To do this, these managers use an effective asset allocation that should generate a positive result in all market cycles.
Fixed income products, including both investment grade and emerging market debt, have become common examples of appropriate asset allocation. Providing a good base for positive return, structured products can be added to one's fixed income investments. Structured products remove at least some of the volatility of the stock market as many come with a 10% to 15% discount. With this discount, potential investors in these funds can reduce uncertainty while maintaining good returns on this portion of their portfolio.
Structured products are becoming common investment choices of high and ultra high net worth individuals and their concentrations are growing. Although some of these products are still equity related, many high net worth investors are using structured products as replacements for their equity allocation. Data indicates that structured products now account for 20% to 30% of many allocations, depending on a client's risk appetite.
Further, many investment gurus believe that, when linked with interest rates, structured products enjoy less risk, as long as one understands that the holding period will probably be longer than with equity investments. If linked with equity products, the risk is high but the term usually shortens. Therefore, the investor has two choices, as one approach is safer in terms of risk but the investment is tied up for a long time, while the other generates more risk, but a delivers a faster return.
Some professionals believe there are large sums of money available for investment now because of record high markets, increased liquidity, improved wealth generation, and an abundance of excess cash. Consequently, high and ultra high net worth investors seek different types of investment vehicles and, of course, higher returns. Further, these investors are increasingly interested in private equity. This strategy is defined as buying a share position in an unlisted entity (privately held company) with the goal of benefiting from the company's as yet unrealized potential. Private equity managers concentrate on absolute positive returns over the longer-term investment period required by this philosophy, usually 7 to 10 years, at times stretching to 15 years.
The two major sub-classes of private equity are well known to the investment community. Strategies may be directed toward venture capital (seed or start-up financing) or buyouts, wherein the investor purchases a share in a mature privately held company that data indicates will be available for sale. Depending on the client's appetite for risk, wealth managers will recommend available scenarios and projected returns the investment might generate, beginning with an effective action plan for asset allocation.
What level of funds should high and ultra high net worth clients consider investing in absolute return solutions? Newly recognized experts recommend clients invest up to 5% of their total portfolio in private equity funds. They universally believe that the combined alternative asset classes should be less than 7% of the portfolio while private equity levels should remain within the 2 to 5% range. Absolute return is more than a new wave theory or short term "fad". It is a well thought out and, to date, effective strategy that projects the consistent returns that are attractive to high and ultra high net worth investors.