Chris Walker reviews 'Alternative Assets - Investments for a Post-Crisis World', by Guy Fraser-Sampson, £34.99, Wiley, 232pp
After the battering they have suffered from investment markets in the last three years, pension trustees might be feeling in need of a little tea and sympathy. They get no such thing from this book by fund-manager-turned-academic Guy Fraser-Sampson. Trustees, we are told are "obdurate", "tragically incompetent", lacking in even "simple common sense" and, overall, have quite basically "failed". They are so dull-witted, in Fraser-Sampson's mind, that they made small and inadequate allocations to alternative assets, often ludicrously "not understanding either what a convertible instrument is or what a hedge fund is". Then, when the crisis happened, they stampeded for the exit in, what he describes as, a "fetish for liquidity".
Unless feeling masochistic, a professional investor might thus be tempted not to open this book, but he would be wrong. Many important investment assumptions challenged by the recent crisis are thrown up here. This book is certainly very thought-provoking and is a good canter through the various options in the alternative assets world.
Is it time for us to question Modern Portfolio Theory (MPT) itself? Too often, this has been expounded by what Fraser-Sampson calls type A personalities - "people who believe in one right answer and the ability of mathematics to calculate it". These are the tribe who created CDOs and the dangerous synthetic structures, and who, sadly, often advised pension trustees. Uncertainty, the author argues, is an inevitable part of the investment process, and "it is their belief that this uncertainty is somehow something that can be calculated or measured … which lies at the core of so-called Modern Portfolio Theory, and bedevils the world of finance".
Fraser-Sampson doesn't stop there. He cuts through liability matching as an Emperor's new clothes exercise. "Ignoring the fact a pension fund's liabilities must be paid not today, but as they fall due … (normally many years hence) … they calculate a net present value of those liabilities". This, he points out, is a hugely subjective exercise, which feeds in a variety of guessed assumptions, the tweaking of any one of which makes an enormous difference to the outcome. He says: "They then set this figure against the present market value of their assets and see their task as primarily managing the risk that these two figures might move relative to each other." The author argues "clearly pension fund trustees, consultants and regulators inhabit some parallel universe where the normal rules of logic do not apply".
An investor's need for liquidity "should be driven by the nature of their liabilities". Sure, an insurance company writing cover against unforeseeable risks needs some liquidity. But, suppose you were running a trust for a baby just a few weeks old - clearly, in that case, there is no need for cash for many years. In this case, "liquidity is actually a bad thing to be avoided, not a good thing to be sought out". Unfortunately, "investors seem unable to grasp this simple principle".
Iconoclasm comes easily to Fraser-Sampson. Active equity management is airily dismissed - it is a "logical impossibility for any active manager consistently to outperform on a net-of-fees basis". Bonds are quite simply "not an investment" and "holding bonds in your portfolio is best thought of as driving your car with the handbrake on".
This is powerful stuff and worth ferreting out in what seems at times a business school primer. I found the opening Plato-esque chapter seeking to define "what is an alternative asset" rather annoying, and the author's obsession with Foucault's concept of 'episteme' is perhaps best left at home. This intellectual framework is established so that he may then lead us to the delights of alternative assets, something we are told he is a well-known advocate of. He sets out to debunk the idea they are more difficult, more risky, dangerous, cranky, optional or unnecessary.
In this, he only partly succeeds. Because at the heart of Guy Fraser-Sampson's book is an act of cowardice - he runs away from his own conclusions. Having spent a lot of time debunking MPT, he then goes on to write a book that is totally within its parameters. Time and again, in seeking to justify investment in alternatives, he returns to the quest for uncorrelated returns. The author himself is critical of "those who believe the past is a guide to the future" and cautions against "blindly adopt(ing) historical data", and yet this is exactly what he does. The events of 2008, when correlation data proved meaningless, might suggest a new approach. But, no, this was all down to those naughty trustees and their silly "liquidity fetish". They created a "man-made correlation". Oh really. What are the others - an act of God?
In leading investors down a path that by his own admission is discredited, Fraser-Sampson is feeding them to the wolves. Instead of defining risk as risk of volatility of returns, why not define it as the risk that you will lose part or all of your investment. Some of the most worrying aspects of investing in alternatives are given insufficient attention. He does admit that high hedge fund fee levels often mean too much of the return is eaten by the managers (the same could be said of private equity). But there is not sufficient discussion of survivor bias in performance returns - a throwaway footnote admits "much research suggests 50% of all early-stage venture companies will fail to return their initial capital".
In a post-Madoff world, issues of transparency and regulation are central to any trustee's due diligence. And yet, as the author himself admits, huge swathes of the alternatives industry are completely unregulated and opaque. And then, post Lehman brothers, there is the clear issue of counterparty risk in any alternative strategy employing derivatives.
I found many aspects of this book very thought-provoking, but longed for the author to have the courage of his convictions. I also concluded maybe trustees weren't such fools after all. Those type A personalities are wolves.
Christopher Walker writes on current affairs and investment issues and is a former investment manager