The alternative space is offering many opportunities for those investors looking for products that deliver uncorrelated returns to equities and bonds, according to BMO Global Asset Management’s Kelly Prior and Scott Spencer.
Prior and Spencer, who have been part of the BMO GAM multimanager team for over 20 years and co-manage the £1.1bn BMO MM Navigator Distribution fund, said they have been gradually increasing their allocation to alternative investments given the attractive risk/reward these types of vehicles offer.
And while many of their peers use these to hedge out exceptional risks through derivatives and may end up not taking any risk at all, the multi-manager team at BMO GAM take a different approach to alternatives.
“What maybe some of the peers do in terms of their use of layering on top of what may be traditional views is you can over-hedge and that is what maybe some people think about the alternative space,” said Spencer.
“They’ll use this area through derivatives to kind of hedge-out exceptional risk, this is what you find maybe in multi-asset funds.”
“When we are thinking about alternatives is about actually trying to layer on an additional element of return and actually take risk out because in an overall fund-of-funds this is what you have to think about.”
Given that bonds are no longer fulfilling the purposes they used to be associated with – such as acting as safe havens while generating uncorrelated returns to equities – Prior and Spencer noted multi-managers are having to find other ways to provide protection.
According to the pair, while the types of alternative strategies they use in their portfolios have been around for a while, they offer attractive yields and tend to have an appealing risk/reward ratio.
SQN Asset Finance Income
Diversified equipment leasing and asset finance listed investment company SQN Asset Finance Income is an example of alternative product the team owns.
The fund’s objective is to provide its shareholders with regular, sustainable dividends and to generate capital appreciation through investment, directly or indirectly, in business-essential, revenue-producing (or cost-saving) equipment and other physical assets.
Performance of fund vs sector & index since launch
Source: FE Analytics
“SQN is a closed-ended fund that rises money and that money would be used for Rolls-Royce engines that in this instance will be used in tomato greenhouses in the UK,” explained Prior.
“So, SQN owns those assets and the company that owns these greenhouses actually borrow those off SQN and, while they do that, they pay them a yield for a set period of time but those assets continue to belong to SQN.
“And at the end of the term they may extend the term, or they will buy them off them.”
According to the manager, while this type of product is very similar to a bond, the yield investors are getting is substantially higher.
“Rather than achieving 2 per cent or 1.5 per cent you are achieving a yield of 8 per cent. To me it is a different type of risk but, ultimately, that is a better deal doing what traditionally a bond would do”.
SQN is up by 20.74 per cent since launch and data from the Association of Investment Companies (AIC) shows it currently yields 7.7 per cent.
Amedeo Air Four Plus (AA4)
Another area where they are currently finding interesting opportunities is the aircraft leasing space.
The team owns Amedeo Air Four Plus, a company that acquires, leases and sells aircrafts to airlines including Emirates, Etihad and Thai Airways.
“This is a very hot space at the moment,” said Spencer. “We like Amedeo Air Four Plus mainly because it’s a higher quality one, it only leases its fleet of planes to state-backed airlines, so its leasing to Emirates rather than Monarch.
“They get less reward, but the yield compensates us for that kind of risk/reward. It’s giving you 8 per cent yield.”
Performance of stock since IPO
Source: FE Analytics
Noting that the space is “as old as the hills” Prior emphasised the importance of engaging with the chairman and board of directors when investing in these type of strategies.
“With AA4 we have spoken to the chairman in many occasions to understand how he is thinking about the overall strategy and what they’re doing and he is a very interesting person to speak to,” she said.
“We need to learn about these kind of niche spaces, it’s not about the high yield, it’s about understanding where the risks are.
“When we talk about alternatives is simple stuff, but you have to understand where the risks are.”
Darwin Leisure Property
The final example of alternative investment strategy the team backs in its own range is Darwin Leisure Property, which provides investors with exposure to the UK holiday park industry.
“They are high quality caravan parks only operating in areas of outstanding natural beauty. What they’ve done is taken very inefficient family-run plots and put on caravans, which are like lodges essentially and they are very high spec,” said Prior.
“Think about the benefits of that: you go from very seasonal business to something that operates all year round, they are in stunning areas, in most cases they put on additional services like spas, etc.
“When you think about it: it is a recession beneficiary because people aren’t travelling abroad, they offer a 6 per cent yield, they win award after award and people go back.”
The £576.7m offshore fund has delivered a total return of 55.83 per cent over the past five years and has a total expense ratio of 1.47 per cent.
Since launch in 2007, BMO MM Navigator Distribution has delivered a 65.07 per cent total return compared with a gain of 48.04 per cent for the average fund in the IA Mixed Investment 20-60% Shares sector.
Performance of fund since launch
Source: FE Analytics
The fund yields 5.10 per cent and has an ongoing charges figure (OCF) of 1.49 per cent.