Alternatives investing: pursuit of uncorrelated investments with attractive risk-return characteristics
Global Investment Insights
with Gareth Abley, Head of Alternatives and Listed Sector Portfolios, MLC
Gareth is the Head of Alternatives and Listed Sector Portfolios at MLC. In this role he manages a AU$3 billion portfolio in diversifying strategies, which includes hedge funds, natural catastrophe reinsurance, specialty finance/esoteric credit, and litigation related strategies. Additionally, Gareth has responsibility for MLCs listed sector portfolio (circa AU$70 billion) - which have their own portfolio managers - as well as the evolution and execution of MLCs ESG process.
“Our job is to find attractive, uncorrelated alternatives for MLCs clients. Our experience has been that most of the things labelled as alternative are not. Often, they are repackaged exposures to equity and credit risk, at much higher fees”, Gareth highlighted.
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Most things labelled as alternative are not. Often, they are repackaged exposures to equity and credit risk, at much higher fees.
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This view has helped define MLC’s investment DNA, which is built around two simple goals:
1. To find investments that have an attractive risk-return in their own right; and,
2. That are also diversifying to the broader portfolio.
Gareth explained further, “one lesson we have learned is that as well as maintaining this clarity of purpose, it is also important to be flexible. In the last few years, we have found attractive strategies in private specialty finance – and we now have six manager relationships in this space. Our research has focused on more niche, esoteric opportunities that we think will be much less correlated than more conventional private corporate credit strategies - financing legal receivables is one example.
These strategies are difficult to find, require a lot of research, and are often not particularly scalable.
A key part of our work in this space is underwriting co-investments alongside our managers – we have deployed AU$700 million across more than a dozen deals over the last two years. This has been a great way to deepen our insight into our managers’ process, improve our understanding of the risks of underlying deals, and become better investors ourselves. These strategies have delivered net returns of ~15% pa over the last 3 years – and while this has been above expectations, we still see attractive opportunities in this space.”
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We don’t apply a macro lens to identifying new opportunities – our approach is to be connected to as many smart people as possible and look down a lot of rabbit holes with ‘open minded skepticism’.
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For Gareth, one of the benefits of assessing alternative strategies is the opportunity it presents to interact with very smart, creative, entrepreneurial people who are operating in, or sometimes, are creating, interesting new niches.
“We don’t apply a macro lens to identifying new opportunities – our approach is to be connected to as many smart people as possible and look down a lot of rabbit holes with open minded skepticism. Being open minded is key because we invariably come across a lot of quirky ideas and while some may be absolute gems, it is important to approach each idea with a healthy level of skepticism, because 95% of the time, the answer should be no”, Gareth shared.
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Our experience is, the more complex, the more quirks, and the more uncomfortable we are, while understanding why we are uncomfortable, the better outcomes we’ve tended to deliver.
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From Gareth’s experience, the sweet spot is often where discomfort is optimised.
He explained, “if all the backward looking due diligence looks perfect, it is rare that the forward looking outcome will be. This is generally because the opportunity and the manager will have been picked over and overcapitalised.
Our experience is, the more complex, the more quirks, and the more uncomfortable we are, while understanding why we are uncomfortable, the better outcomes we’ve tended to deliver. One aspect of this is what we call hairball risk. Managers that have stubbed their toe, have some headline risk, that have tasted a drawdown… the ones that may be easy to scrub off the list… are often more risk aware, more hungry, more humbled, and, as a result, can often be in a capital starved niche. It is these that have often led to some really great outcomes.”
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The days of a hedge fund pitching its secret sauce are gone, from our perspective. For us, transparency is a win-win.
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Gareth believes that the industry would benefit from greater transparency. “The days of a hedge fund pitching its secret sauce are gone, from our perspective. There are two reasons to be opaque – one is because you have magnificent intellectual property (IP) that needs to be kept secret, and the other is because your IP isn't very magnificent. The skeptical view is the latter, is usually the more likely”, he opined.
“We have huge respect for the skillful and proprietary work that is done by managers – and we are very sensitive about respecting and preserving this IP. For us, transparency is a win-win. Our strongest relationships, and the ones that will endure the inevitable performance hiccups, are the ones where the manager has ensured we are eyes wide open on all the risks”, Gareth affirmed.
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We have huge respect for the skillful and proprietary work that is done by managers – and we are very sensitive about respecting and preserving this IP.
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We asked Gareth, what is keeping him up at night with respect to his role and he left us with a couple of thoughts that are top of mind for him currently:
“Firstly, making sure that we are focused on what is likely to give the biggest bang for the buck for our investors. There are so many interesting angles to explore in alternatives. We aim to strike the right balance between being open minded and creative in looking at lots of things, with the discipline to know when to focus on where the impact is likely biggest for our clients. I am lucky that I work with an incredible team that does this really well.
Secondly, it feels like there is strong momentum towards a more conscious, sustainable form of capitalism – particularly with regards to climate risks. This is obviously a really complex issue – but the more we are collectively thinking about it and openly debate it, the more likely we will get to the right answers”, Gareth concluded.
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There is strong momentum towards a more conscious, sustainable form of capitalism – particularly with regards to climate risks.
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Disclaimer
The views expressed in this publication are solely those of the individual and do not reflect those of their employer organisation.
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The authors, directors or guest writers may have a financial interest as investors, trustees or directors in investments discussed or recommended in this document. It has been assessed by the editors that these financial interests have not had an impact on the material contained here within.
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