Wagging the dog

11Sep06

Are alternative investments the “tail wagging the dog” that is the broader investment world? A quick glance at the categories of this blog indicate that we are not immune to the many topics that are included under the aegis of alternative investments. Even after some rapid growth alternatives remain a small part of the investment world.

Gillian Tett at FT.com reviews some research by JP Morgan that shows that the world of alternative investments has reached $3,000 billion up from $2,300 billion 18 months ago. This compares to the broader global capital markets that they estimate at $60,000 billion. These estimates are not all that different from some earlier figures we touched on previously. While these estimates are tenative given the often private nature of many of these funds, it demonstrates a continued interest on the part of institutional investors to seek out new sources of alpha.

Two important things are at play here. First these figures surely underestimate the nominal assets that alternative investment players have at work. Leverage, via derivatives and other borrowing, allow these investors to gross up their assets so as to best maximize their returns.

Second, and maybe more importantly, is that these areas have been a magnet for tremendous amounts of talent (and capital). It is hard to ignore the fact that investment banks continue to lose talent to hedge funds and private equity shops. For those looking to maximize the payoff from their skills these vehicles are now the preferred paths to wealth generation.

We have taken two approaches in our coverage toward alternative investments. The first approach is to focus on the way hedge funds and private equity affect the publicly traded capital markets. For instance we discussed the fact that mega-buyouts may buoy the performance of the then lagging megacap sector.

The other approach is to try and find vehicles that allow individual investors to access these types of returns. For instance the growing slate of hybrid funds gives investors a way to gain exposure to hedge-fund like strategies. Another, more complex way, is to create so-called synthetic hedge funds that generate returns like that of the hedge fund indices.

With most corners of the global capital markets already covered in one way or another individual investors seeking out “radical diversification” are increasingly looking to alternative investments. Don’t look for this trend to change anytime soon.

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