Henry P. Davis, managing director of Arden Asset Management, answers our questions about the utilities and misconceptions surrounding alternatives and the increasing availability of these strategies to advisors and individuals.
This article originally appeared in the June/July 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
1 Why invest in alternative investments?
Alternatives provide differentiated or “alternative” return streams from traditional investments. Alternatives may enhance portfolio efficiency and diversification, resulting in more attractive portfolio characteristics (e.g., higher risk-adjusted returns and lower overall risk).
2 What is the biggest misconception investors have about alternatives?
One significant misconception investors have about alternatives concerns their riskiness. One often hears references to hedge fund managers “making bets,” “gambling,” and so forth, whereas in reality many if not most managers follow disciplined strategies that are designed to reduce risks associated with riskier assets. For example, certain hedge-fund strategies such as Equity Event employ
process-driven methodologies with hedges designed to mitigate risk.
3 Sophisticated alternative strategies are becoming more available to advisors and retail investors through mutual funds. Is this development a good thing?
Yes, I’d say it’s a great thing. It’s all about leveling the playing field by providing individual investors access to strategies previously only available to institutions and the very wealthy. It means more choice, more options for building portfolios, hereby increasing the likelihood of meeting one’s investment objectives in an environment of lower overall expected returns. I look forward to the day when my kids will be able to make diversified hedge fund investments in
their 401(k) plans.
4 What’s the biggest drawback of this trend?
Some hedge fund strategies do not fit in a daily liquidity mutual fund structure owing to the less-liquid nature of some of their underlying holdings.
5 Would you be interested in managing a mutual fund?
Yes. In fact, we have launched Arden Alternative Strategies I
with attractive diversification properties in a daily liquidity format.
6 What’s the most important attribute that you look for when selecting a manager?
Integrity, discipline, and judgment all tie for most important attributes in a manager. A close second would be “seasoning,” meaning a manager who has survived and thrived in the face of difficulties and challenging market conditions.
7 What’s the biggest challenge to investing in today’s climate?
The biggest challenge for investing today is the “financial repression” that has
been created by artificially low interest rates that places savers and particularly fixed-income investors at a disadvantage relative to borrowers. Fixed-income investors face significant risks in the event interest rates rise from current historically low levels.