Colin McLean, managing director of SVM Asset Management Ltd, explains how charity trustees can take advantage of changing investment techniques.
New investment techniques rarely get much attention from charity trustees. Stewardship of charity assets is focused on long-term strategy, protection of capital and prudence. Many feel that traditional investment approaches have served the sector well. Yet the investment landscape is changing, with new potential for efficient portfolio management within unit trusts, OEICs and Undertakings for Collective Investments in Transferable Securities (UCITS). Trustees need to understand this new world and the potential risks of what they thought were conventional funds.
Few charities have been attracted to hedge funds, despite some high-profile investors such as the Wellcome Trust. But many other conventional funds can now use hedging techniques and, increasingly, the line between conventional funds and alternative assets is becoming blurred. In particular, the new UCITS III regulations allow UCITS funds to use a wider range of instruments in an attempt to enhance returns, mitigate risks or reduce costs. Investment trusts have been able to do this for some time, with an increasing number taking advantage of the flexibility. This ranges from trying to neutralise currency exposure in, say, a global investment trust, to writing options to gain income, or trying to reduce the potential impact of a stock market fall. Charities may not want to use these techniques and instruments, but will find that many pooled funds they own are using the new freedoms.
In the US, many endowments and charities have invested in the new areas. One popular type of fund, called 130/30, sits somewhere between conventional and hedge funds. It combines a geared, traditional, long-only portfolio with some hedging. In effect, clients get a high conviction portfolio exposed to stock markets. But there is also the potential for a little more stock-picking alpha from some additional longs and shorts. This approach has already attracted an estimated $50bn in assets in North America, with pension funds being the first buyers of the strategy. It provides a step towards accessing additional manager stock-picking skill, but typically with more limited risk than hedge funds. Fees also tend to be nearer those typical of conventional funds. UK pension consultants are already showing interest in the concept, and there is talk of new fund launches.
However, the potential for active risk management and additional manager skill already exists in conventional investment trusts. Provided hedging positions reflect genuine risk management, there is a wide range of instruments available to fund managers. Indeed, global generalist trusts have used currency hedging on many occasions over the past two decades, and several trusts also create additional revenue by writing options against the core portfolio. Of course, investment trusts have always had the ability to borrow, and to gear up a fund to, say, 20% according to stock-market conditions, is used by many.
Trustees buying a fund that is using these techniques will need to be sure of the manager’s experience and the controls applied by its risk-management team. The strategy should be explained to investors. It is not a licence to create a trading fund, but permission for a specific level of additional stock-picking. This may be closer to a manager’s skills than market timing, but will also give a fund the opportunity to go significantly below full market exposure in a downturn.
Investment trusts that have taken advantage of a wider range of securities should get more attention. They provide an attractive entry point for those who want their favourite managers to have a broader range of tools available in order to deal with a change in market conditions. Already, the flexibility that gearing and hedging offers has helped some with performance and risk management. More widespread use of these techniques in the investment trust industry could offer real competition for UCITS IIIand hedge funds. Charities should understand the whole range of efficient portfolio techniques now available.
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