Most people au fait with markets have heard of Warren Buffett. 
Benefitting from the rising tide of stock markets over multiple decades, this may have turned him into one of the world’s richest men, but Buffett himself is honest enough to attribute much of his success to his mentor, Benjamin Graham, the father of ‘value investing’ who put everything into a book "The Intelligent Investor".
The success of the Buffett/Graham 'value investing' approach is founded upon sticking to core investment principles; invest into what you know about and avoid the failure of fads or poor behavioural traits that result in investors incurring losses that will never be recouped by their winners.
Investors need to have a ‘margin of safety’ in the excess returns they hope to receive from equities over ‘safe’ government bonds, and they should buy/sell relative to their intrinsic view of a company’s worth rather than what the stock market is saying about the price.
Some, however, are now asking how these principles can be applied in today’s world.
Central bank monetary policy has left a massive portion of the developed world's bonds trading at negative yields – so anything with the potential to produce a real positive return appears acceptable.
This has forced investors down the quality/risk spectrum which creates a self-fulfilling cycle with money spreading out to buy other assets – property and stocks – in so called ‘yield tourism’.
At the same time bond issuers have taken advantage of low interest rates to issue debt, very little of which has been used to pay for new factories or real assets. Instead, much of it has been used to fund share buy backs - pushing up equity prices.
But consider the logic that if bond yields are falling, it should be because investors are nervous about prospects like economic growth. Forward pricing markets should therefore be looking at declining earnings and stock prices should fall.
This hasn’t really happened though, so perhaps investors have seen past the usual clue that bond markets provide and are cognisant of the distortions of central bank policy. Where does all that leave the concept of value investing and the safe bond yield?
There are a couple of ways to navigate these problems.
The first is to invest long term and accept the market's distortions and the volatility that will inevitably arise, but not all can take a long-term view or have a Buffett type buffer of capital.
Moreover, not everyone has Buffett's skillset to understand and the ability to select which stocks are undervalued and worth buying.
In the modern world we call it 'alpha' - the ability to generate stock specific superior investment returns. Other forms of ‘alpha’ however can potentially be captured elsewhere from investments that aren’t included in the ‘beta’ of equity or bond indices.
They involve investing largely outside the volatile bond and stock markets and looking for investment returns from non-correlated but understandable assets. Indeed, many of these assets can be considered ‘real’ and tangible, certainly characteristics of which Mr Buffett would approve.
Alternative investment is growing as banks retreat from lending activities and nonbank lenders (investors) look for better and more predictable returns.
These alternative assets therefore can take the form of financing aircraft, heavy machinery, reinsurance, or infrastructure and either have high levels of secured asset backing or long life government contracts.
Many of these assets throw off predictable cash flow which is an improvement on a lot of the companies in the stock market ‘casino’ which are valued on future potential, that may or may not happen, and operate in extremely competitive environments.
Until recently such investment opportunities were the preserve of the investment banks, but now pension funds and insurance companies are increasingly lending direct on such assets, whilst retail or private investors can gain access through an increasing number of stock exchange listed investment vehicles which provide indirect exposure.
Admittedly the risks are very different, but that’s the point.
They’re not always the economic cycle risks of most businesses, or even the competition risks which many businesses face in sectors where there are low barriers to entry.
Additionally, what CFA trained fund manager used to looking at cash flow statements and balance sheets, with dealers only used to equities or bonds, could cope with selling an Airbus A380 inadvertently owned after an airline defaults on its lease?
That is why there are, of course, management companies around these vehicles who deal with these operational considerations.
Herein Buffett has reservations about the layer of fees, but this criticism is really saved for the alternative assets of hedge funds and private equity where the fees cannot be viewed in the context of reasonably assured returns. Another of Buffett’s key attributes is that he thinks of his investments as an owner rather than a stock holder.
Along this parallel, he must agree there is value in the ‘utilitarian’ aspect of many alternative assets. Moreover, precisely because they are not necessarily volatile in price, they lend themselves to being long-term holdings for a portfolio, which also fits with Mr Buffett’s long term ownership principles.
Steven Richards is associate director at Thesis Asset Management. All the views expressed above are his own and shouldn’t be taken as investment advice.
