Transcript | Episode 5 – Alternative investments

Sarah Widmeyer: Welcome to Conversations on wealth hosted by Richardson GMP. A podcast dedicated to helping Canadians navigate the complexities of wealth with a multi-dimensional approach to planning and wealth management. I'm Sarah Widmeyer, Director of Wealth Strategies at Richardson GMP, and this week we’re discussing alternative investments.

Joining me is Romain Marguet, Vice President of Alternative Investments at Richardson GMP. Welcome Romain.


Romain Marguet: Thank you very much for having me.


Sarah Widmeyer: So, alternative investments – sounds like an exciting topic!


Romain Marguet: Well, I think so, but I guess I'm a bit biased.


Sarah Widmeyer: It is used as a strong complementary piece to some client’s portfolios, but they might not know what opportunities are available to them. Romain, a natural starting point for this conversation is probably, what are Alternative Investments? It sounds like this big scary thing. How does it work?


Romain Marguet: Absolutely, that's a great question. And actually, myself, I don't love the all-encompassing alts because “alternatives” doesn't really suggest what exactly you're looking at. But what the financial sector deems to be alternative investments would be private real estate and infrastructure, private equity and venture capital.


Sarah Widmeyer: Okay, hold on. So private private equity meaning what?


Romain Marguet: So it's equity you're buying companies, but it's not listed stocks and bonds. So it's in the private market, it's not traded on an exchange. Venture capital is essentially the same type of idea, except it's earlier stage investments. And also hedge funds obviously are considered alternatives. Hedge funds themselves are a very broad and highly diversified group of funds. So it is a very large spectrum spanning, because if you look at it, real estate or private real estate really has nothing to do with a global macro hedge fund. Yet, they are grouped in the in the same category and their uses are completely different. And the people who should use them are coming to accomplish completely different goals.

Most hedge funds would be dealing in trading stocks or bonds, or both, on exchanges. Except what they do versus a regular mutual funds tends to be slightly more complex. They will they will add things like shorting of stocks, they will add things like leverage, they will add things like derivative and futures contracts, which are all publicly listed and traded, but much more complex than an ETF definitely or even a simple mutual fund.


Sarah Widmeyer: So it sounds like then with complexity comes sophistication of investors. So I'm guessing that these types of investments are not meant for everybody.


Romain Marguet: No, generally speaking, what we use in Canada or what we use here at this firm to be able to invest in in private real estate, infrastructure, private equity, venture capital tends to be only for what we consider high net worth or ultra high net worth individuals. And the the criteria tends to be what's known as accredited investor. An accredited investor is somebody who would have over $1 million of financial assets or also qualify as making over $200,000 a year. Now those qualifications are, you know, sure they can qualify you to buy private real estate or hedge funds. But to properly incorporate those into an overall 60/40 type portfolio, you tend to need substantially more assets than this to be able to add across this type of alternative asset base.


Sarah Widmeyer: So within a 60/40 asset allocation strategy – 60% being equities and 40% being bonds – this would fit in the equity bucket.


Romain Marguet: It fits in both.


Sarah Widmeyer: Okay, but let's just focus on the equity bucket for a minute. It wouldn't be 60 in alternative investments. you would be some percentage of the 60.


Romain Marguet: Yeah absolutely. We clearly have room for a variation on the 60/40 where you're still buying ETFs and mutual funds, or direct stocks and bonds, and complementing that with a share of the portfolio being allocated across the asset classes that I brought up. That number can vary tremendously. If we look at it, 20-25 years ago when pensions and endowments started doing this type of work, they trickled into it. They had 5-10% allocation and now the the largest most sophisticated smart money, as they're called, often has over 50% in these asset classes.

Am I suggesting that for the average high net worth individual they need to skip right to 50%? Absolutely not. What I am suggesting is that it would probably make a lot of sense for people to – who haven't looked at these asset classes – to do so and build it into the portfolio to a level that makes sense. It could be first a 5% allocation of the overall portfolio and eventually building it to – what we see in the high net-worth space is often building it up to 25%. That tends to be where we take a lot of our high net worth portfolios.


Sarah Widmeyer: You mentioned pension funds and endowment funds. I think it would be interesting for investors to know that alternative investing has been a strategy that's been around for years, decades, in the pension space. Craig Basinger had come on an earlier podcast with us and he spoke about the explosion of choice for investors. Things that have changed over the years as the explosion of choice, with alternative invest being one of those choices now. It would be good for investors to know that this isn't a new asset class, as such. It's new to private investors, individual investors, but it's been employed in pension funds and endowment funds for years.


Romain Marguet: It has, yes. Even sophisticated wealthy families have been utilizing hedge funds and private equity for decades. Being able to access these asset classes has been difficult for people who didn't have tens of millions of dollars. Now it's been more commoditized and we're able to access high quality products even for one or two million dollar portfolios.


Sarah Widmeyer: Which is great for those investors that have the risk appetite to to go there.

So explain to us if you would, what an investor needs to know about non-traditional assets.


Romain Marguet: There's so many angles to this, and obviously it's difficult to to have an overarching strategy that applies both to private real estate and private equity. No matter what, as an investor, once you're looking at these asset classes, the first things you have to realize is because they're more complex it often requires much more work in your due diligence. And there's never a free lunch. So often people come to me and say “oh my god the the terms on this look absolutely unbelievable.” There's always something that you have to give up.

In private equity, or private real estate, or private debt, sure, you can have often higher return expectations than in public markets, but very often you're giving up liquidity. And then when you're giving up also potentially transparency, that requires you as an investor to do more work, because often you can't pull up the holdings of your private equity fund simply by Googling them. That requires more work or the people that you're dealing with, they'll have to do more work to keep up to date with these investments. I think one of the key things is not just identifying a great manager within these asset classes, it's also being able to follow that manager on an ongoing basis. And that's even more crucial with alternatives because it's not being tracked on whatever website that you can go to, or on Bloomberg where you can see exactly what that mutual fund holds. To be able to follow what a private equity fund or private debt fund does, it requires first hand work, it requires meetings, it requires calls with the PMS. Really that's something that at this firm we've not only pioneered, but we've definitely created the most robust platform in the Canadian space.


Sarah Widmeyer: A couple questions that come out of that is, I think the first question that I would have would be: So with this complexity, with the additional work, with the additional amount of research that is required, are they more expensive to buy than regular more traditional types of investments?


Romain Marguet: That's a great question. Generally speaking, yes they are. The management fees and often the performance fees on these funds are substantially more than, obviously, an ETF. And that's because they're actively managed, their capacity constraint and the strategies often require far more work, and therefore the manager deems that they should be compensated for it. So as an investor, what's very important is really to look at what your returns are net of fees. That's the crucial part of this obviously. The industry is really standardized itself to report all returns back to investors net of fees. On that basis I always argue that even if you're getting charged an MER of pushing 3%, in some cases, if on a risk-adjusted basis you you still made 10% I'll take that every day over making 5% and only paying 20-25 bps.


Sarah Widmeyer: One of the benefits then, the primary benefit, is that alternative investing gives you an opportunity to achieve better returns than average.


Romain Marguet: Yeah it's it's actually twofold. So what you look for as a whole in an alternative investments is not simply the return. Obviously you would be buying private equity and venture capital for the return profile of those assets. But the hedge fund as a whole now is mostly driven by my funds that are trying to de-risk portfolios. As a whole when you're looking at alternative assets, a word that's always thrown around is correlation. So that really defines is the return stream of the funds you're buying diversified from the other return streams that you hold in your portfolio currently. That's the crucial aspects across all these asset classes that you look at.

You don't want to be buying a fund that will mimic the return profile of your other mutual funds or your other stocks. You want something that will be able to not only provide upside when the rest of your portfolio is suffering but also really insulate your portfolio in the toughest times from losing capital.

Many alternatives are now being used from a risk management perspective because in an ‘08 scenario, what assets didn't lose money, what assets made money? In that case if you were able to have owned those assets at a time when the majority of your portfolio was suffering, you would have been able to generate capital through other assets. This mitigation of volatility is is really one of the key tools in bringing alternatives into a portfolio. It's not simply looking for for outsized returns.


Sarah Widmeyer: That's the word – hedge. You're hedging your portfolio, hedging your risk, and in my language if everything else is zigging ,this might be zagging.


Romain Marguet: That's the entire point. I would even argue that there are some hedge funds out there that's portray themselves at hedge funds, but when you really do your work and you dig into it, you realize that they're actually highly correlated to the stock market. Therefore the question begs why buy this specific fund? That's why these asset classes require so much work. You really need to be able to sort through the strategies, the teams that run them, the firms that operate them, to make sure that you are getting what you think you're getting.


Sarah Widmeyer: I know that many clients who are interested in alternatives, such as hedge funds and other types of funds, want to know more about socially responsible investing, or otherwise known as SRI. Also environmental social and governance investing, which is known as ESG. In fact SRI mandates are growing in popularity. What can you tell us about the opportunity in SRI and ESG, which is again environmental social and governance investing?


Romain Marguet: The entire segment of impact investing, or SRI, ESG, is definitely growing, and specifically in the last few years within the high-net-worth and ultra high-net-worth segments. Once again very much pushed by the pensions. Certain pensions and endowments really started pushing towards more socially conscious and governance conscious investments a decade ago, and now that's trickled its way down to our high net worth portfolios.

We happen to be in a great spot at this firm because not only do we have easily the most robust alternative platform, but that also means that now all the alternatives that are coming out that are impact and ESG conscious, we are the the first people to look at them and try to implement them into our portfolios. It's definitely grown tremendously. There was very limited offerings even 2-3 years ago, and now we're seeing many more opportunities in venture capital, for example, with clean tech funds, we're seeing opportunities in private equity with, once again, clean tech or renewable energy, private credit funds in Canada launching a focus on on social impact. So there definitely are very interesting opportunities and I really believe that in the next few years this will easily be one of the fastest growing segments of the alternative world.


Sarah Widmeyer: It's interesting because as you watch, people are becoming much more aware of our environment and preserving our nature, our environment. I know that it's a trend. it's a big trend particularly in the female investors, to equate doing well with doing good. And so I see that as a trend that's coming up through the demographics and I see that absolutely finding a home in investment portfolios.


Romain Marguet: It definitely is and that also means that the flip side to that story is, whenever there's anything trending in the investment space it means that you have to be very conscious about keeping your eyes still on the ball. This is still an investment vehicle, and therefore not only looking at at the merits of their impact, or their SRI or SEG bend, and understanding that no matter what, your due diligence is still key here. You still have to identify strategies that make sense, investment teams that make sense, firms that make sense, because otherwise your your whole goal of having an impact will go down the tube. If they can't perform and deliver on what they're trying to do, which is still the basis of what everybody's trying to accomplish. And I have noticed that specifically in this segment people can get lost in the in the marketing and not enough into the into the merits of this team executing on that marketing.


Sarah Widmeyer: Right, and the thing to be aware of is that charitable donation receipts are not given. These are investments and need to be judged on the investment merits of the portfolio.


Romain Marguet: And the wonderful thing is that you know there are teams that are seasoned for decades that are now getting into this space and therefore you know that's it's becoming easier to find high-quality investment value propositions that also have an impact and SRI and ESG path.


Sarah Widmeyer: That's great. How would a client go about choosing the appropriate one for their portfolio?


Romain Marguet: That's the million-dollar question. Finding the alternatives that makes sense for your portfolio starts with doing some work around what it is you're trying to achieve as a goal. Are you trying to mitigate capital loss, are you trying to increase alpha by, and therefore looking at potentially private equity and venture capital, are you looking for more income and therefore are you going to look at private debt? Following that, it's making sure you you don't simply talk to the the first fund that comes around. You have to work with people who have an unbiased – and I say that because that's extremely important – an unbiased opinion of the field that you're looking at and work with them to get comfortable with the mandates that are available and the ones that are suited for you. And that's truly something that we bring to the table here with our team at the firm.


Sarah Widmeyer: I'm glad you mentioned that because it's certainly something that we have at the firm that we both work at. We have invested in this space and we have said that this is definitely a differentiator for us. Where as in other bigger firm there may be more risk adverse to going into this area of expertise. this is something that we've absolutely doubled down on and said this is an important.


Romain Marguet: That’s the key. You said this firm invested in this and I and I think that's that's the key term. The fact is, many other firms aren't willing to invest in this. It's not even a risk issue. Many of these guys on the investment committees of other firms are very bright and understand the the value of adding uncorrelated assets to a portfolio, and therefore mitigating risk. But it's a large undertaking to build out a team that has expertise within these asset classes.


Sarah Widmeyer: Right. Any other common myths that we haven't covered of alternative investments? I know that the biggest one is that it's risky.


Romain Marguet: It is, and that's the one that I often deal with on a daily basis because, like I said, the fact is most of the time high net worth families who have expansive alternative portfolios are not doing it to generate more returns, they're doing it to not lose money. That is a fact, and a fact that I deal with every day. So that's definitely a myth. The the other one would be that, there's unfortunately been stains in different asset classes. Hedge funds had Bernie Madoff, and anybody who used somebody or went through that story obviously thinks of hedge funds and correlates it to Bernie, which is not a benefit whatsoever. I will definitely say that it's basically impossible to replicate what it is that he did, so that is absolutely good news, and it's not something I've ever come across again.

Like I said, most of these investments aren't swinging for the fences. Most of them are trying to preserve your capital. Also, while these investments are inherently not transparent and often people will use that as, well you know I'm very happy owning this mutual fund I can just go online and see exactly what's being held in my mutual fund – that is something that is more difficult to do with private assets, but every legitimate firm will give you transparency into their portfolio. It wasn't the case maybe ten years ago, but it definitely is the case today. If you want to compete globally, if you want to if you want to be an institutional grade firm you have to give full transparency into everything that you hold and everything that you do. It's definitely something that I've been pushing for with every single firm that we work with because without that I don't think you're you're an investable strategy.


Sarah Widmeyer: Right. Before we wrap up is there anything else you'd like to add, anything that I forgot to ask you about or any words of advice?


Romain Marguet: The key takeaways is always proceed with caution, take advice from people who are able to deliver unbiased advice and don't be scared to roll up your sleeves. The fact is, this isn't like buying an ETF. You have to get your heads wrapped around various aspects of all the nuances of all the different types of strategy that fall under the the alternative space. But the fact is, there's a proven track record over the last 15-20 years through downturns that clearly points to the fact that you can you can outperform the benchmarks by quite a bit by building these into your portfolio the right way.


Sarah Widmeyer: Thank you. The last word that I might add is certainly talking to an Advisor at Richardson GMP would be a great place to start because we have access to great expertise that can help guide a proper portfolio allocation to alternatives and hedge strategies.


Romain Marguet: Yeah, absolutely. Like I said – and clearly some people might say I'm biased – but we've easily built the strongest team in this space in Canada to allow high-net-worth individuals to build these types of assets into their portfolios.


Sarah Widmeyer: Awesome. Romain thank you for joining me today to share your expertise on this topic. If you'd like to learn more about alternative investments please visit our website at RichardsonGMP.com or reach out to your advisor to discuss opportunities remember to subscribe to conversations on wealth wherever you get your podcasts, and follow us on LinkedIn for a broad range of information on wealth strategies. Thank you all for listening, and join us again for our next conversation.


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