| Ireland at the forefront of Europe on alternative investments |
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| Ireland at the forefront of Europe on alternative investmentsMerrill Lynch's recent wealth report highlighted the importance of providing specialsied investment advice to the world‚s wealthiest, and noted that Ireland, the UK and Switzerland had the most developed alternative investment markets in Europe. |
Last year’s volatile stock markets, particularly in technology has impacted the world’s wealthiest according to the annual wealth report from Merrill Lynch. The report estimates that the rate of growth in the number of high net worth individuals (HNWI) and ultra high net worth individuals (UHNWI) has slowed to 8 per cent, from last year’s estimate of 12 per cent. But interestingly the report highlights the growing interest and demand for very specialised investment products for these clients.
According to the report ‘HNWIs in the second quarter of 2000 moved out of high-tech stocks into blue chips and utilities. By the second half of the year the broad decline of equity markets convinced HNWIs globally to reduce their equity holdings and begin moving into fixed-income funds and cash deposits.
‘European investors cut back their investments in the US and Asian stock markets, while Middle Eastern and Latin American HNWIs withdrew the most from equity markets globally. This evidence suggests, overall, that HNWIs behaved wisely in 2000, taking quick measures to protect their capital.’
Given the events of 2000, Merrill Lynch says it expects HNWI wealth to grow by 8 per cent a year over the next five years and reach $39.7 trillion in 2005.
Specialised products
The wealth report finds that specialised investment products are becoming increasingly important to the world’s wealthy investors.
‘These products offer important potential benefits in terms of performance and risk management, and constitute a fast-growing market that any player serving HNWIs would be wise to incorporate into its product and service offering.’
Specialised products span the spectrum of financial instruments not covered by equities, bonds, deposits, and the traditional range of collective investment vehicles such as mutual funds. They can be divided into two broad categories: structured products and alternative investments.
‘Structured products are generally aimed at reducing risk or enhancing returns on conventional investments, and are widely used in managing portfolios. Common applications include accessing volatile markets with full or partial protection of principal, protecting an existing investment position, creating liquidity for concentrated equity positions, and providing tax-efficient investment solutions. Broadly speaking, structured products can be categorised into four types: hedging strategies for single stocks, principal protected notes (PPNs), income generating notes, and index trackers.’
Alternative investments
‘Meanwhile alternative investments are less individually tailored than structured products and fall into three key product areas: hedge funds, private equity, and managed futures funds. The alternative investment market is currently worth over $1 trillion and is dominated by North American investments.’
Hedge funds have several distinguishing characteristics that differentiate them from other investment vehicles such as mutual funds. Hedge funds are generally unregulated investment vehicles, allowing the investment manager substantially more freedom than regulated alternatives, where the percentages of derivatives, leverage, and cash may be restricted by law. At the end of 2000, an estimated 6,000 hedge funds worldwide accounted for $400 billion of assets, 80 per cent of which were held by HNWIs and UHNWIs.
Private equity products comprise investments in private companies. Investments can be made at any stage of a company’s life, but are usually divided into two categories: venture capital and buy-outs.
Managed futures funds invest in a wide variety of global markets, but solely through futures, options, and currencies, which is their distinguishing feature.
Accounting for approximately $44 billion in 2000, total managed futures assets are less than a tenth the size of the hedge fund market and less than 5 per cent the size of the total alternative investment market.
Market penetration
So far relatively small numbers of sophisticated HNWIs are responsible for the rapid growth of specialised products. The report estimates that only 22 per cent of HNWIs have invested in a structured product, and less than 20 per cent have selected alternative investments. Currently, therefore, specialised products account for only a small portion of their portfolios: 9 per cent for HNWIs and 17 per cent for UHNWIs. But according to Merrill Lynch these percentages are set to grow over the next three years given the products‚ benefits, the falling minimum investment amounts, and shortening lock-in periods. ‘Another indication that these products will soon take off is their high growth potential outside North America. North American investors represent the most advanced market for specialised products, and 86 per cent of alternative investments are currently held in US-based funds. Once the benefits are clear, HNWIs around the world are likely to follow suit, creating an upsurge in demand for alternative investment funds in their regions.’
‘This growth will almost certainly begin in Europe. Already, albeit on a small scale, the UK, Ireland, and Switzerland have the most established alternative investment funds, with 95 per cent of European hedge funds management based in London. In the past two years, 25 per cent of applications to the UK’s Financial Services Authority for new funds have been for hedge funds. In the rest of Europe this growth might be more restrained due to regulatory restrictions and, in some cases, adverse tax consequences for investors in certain alternative and structured investments. These regulatory and tax constraints on equity-based vehicles have precipitated a recent flurry of certificates (debt structures) in Europe, whose performance is loosely linked to the returns of an index of hedge funds. Specialised products have substantial potential, but it will be realised only if providers can increase investors‚ knowledge about their benefits and overcome the perception that they are simply too risky.’ |
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| Article appeared in the May 2001 issue.
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