risks of the emerging markets sector as

a whole.

This is potentially a reason why this

asset class is under-represented in many

portfolios - investors are seemingly

reluctant to accept that a standard

approach to risk management through

portfolio diversification is sufficient to

mitigate the overall level of risk associated

with the EMD asset class.

However, this view is not borne out by

trading patterns - improvements to

monetary policy and other structural

reforms have seen local debt volatility fall

significantly in recent times. Moreover,

EMD has outperformed most asset

classes over the past decade - not just

in absolute terms, but also on a risk-

adjusted basis.

Distressed debt can be defined as

being the corporate bonds of companies

that have either filed for bankruptcy or

appear likely to do so in the near future.

The traditional investment approach

involves becoming a major creditor in the

first instance by snapping up the bonds

of the 'target' company at a fraction of its

paper value.

This provides the element of control

required to 'call most of the shots' during

corporate restructure or liquidation. In

terms of security subordination, the

ownership of corporate bonds confers

priority over shareholders in terms of the

right to reimbursement.

Consequently, the prospect of incurring

a total loss of injected capital is remote,

even where the business concerned

succumbs to outright failure. Indeed, the

well-publicised demise of Enron in 2001

and WorldCom a year later helped to

provide investors of distressed debt with

staggering returns approaching 50% in

one calendar year. However, since then a

lack of large bankruptcies has meant that

the most widely-quoted indices of

distressed debt have offered

comparatively lean returns.

Nevertheless, not all distressed debt

strategies are contingent on the existence

of high-profile bankruptcies in order to

achieve attractive investment returns. The

conventional approach is often referred to

as 'control-oriented' and is based on the

premise of achieving spectacular results

from a small number of investments

within a concentrated portfolio. As a

result, they can be somewhat hit or

miss in nature.

Conversely, 'credit-intensive' distressed

strategies do not seek all-or-nothing

performance and are based on the

pursuit of liquid and diversified 'minority'

positions which are taken across the

pre-default ('stressed') and post-default

('distressed') spectrum.

This makes it possible to achieve

recurring, incremental returns which

are noteworthy for their consistency

rather than their fluctuating nature.

Private equity

Private equity refers to medium to long-

term finance provided to a company that

is not quoted on a stock exchange in

return for an equity stake in the same

potentially high-growth business. The

funds that a company raises through

private equity can be used to develop

new products and technologies, to

expand working capital, to make

acquisitions, or simply to strengthen the

corporate balance sheet.

Many institutional investors have

been deterred by the fee scales involved.

However, it has always been the case

that providers of what is seen to be

an extremely specialised proposition

have been able to demand top dollar

for their services.

It is only when competition becomes

more rigorous, and the overall reach

of the industry concerned expands

markedly, that the tag of exclusivity

is shed and the profitability of running

such a business declines from supra-

normal levels.

Conversely though, lower fees

aren't necessarily the panacea, it is

attractive net returns that the clients

value. So, while lower fees are a good

thing, this should not come at the

expense of performance.

There are some structural issues

which dictate that trustees of charities

need to take a measured approach to

investment in private equity, which itself

means that it can take time to find the

right investment.

In addition, the assets are typically

locked away for at least three to five

years and this lack of liquidity needs

to be compensated for to ensure that

the overall investment objectives are

not compromised.

Nevertheless, the diversification

benefits and superior return potential

mean that opportunities to invest in

private equity require serious consid-

eration. Having said that, it would be

wrong to imply that private equity

constitutes an appropriate investment

media for each and every charity - much

will depend upon the size, funding status

and investment objective.

There are potential pitfalls associated

with each of the above mentioned asset

classes for the uninitiated, but there

are ways in which the prospective

benefits of these alternative forms of

investment can be harnessed in a very

productive manner.

It is possible for charities to gain

access to carefully constructed portfolios

covering each of these asset classes,

which could, individually and collectively,

offer a very attractive risk-adjusted return

expectation. The key is to ensure that the

appropriate advice is sought and that the

trustees are able to gain a full under-

standing of the dynamics to ensure that

any such proposition fits in with their

overall investment policy.

HSBC Global Asset Management has a

dedicated team of charity investment

professionals serving over 400 voluntary

sector clients.

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Institutional investors have long been

reluctant to embrace new develop-

ments and innovations in investment

strategies. Indeed, UK institutions lag way

behind those of other major countries in

terms of their participation in financial

products such as hedge funds.

Yet much of the research that has been

conducted into the potential benefits that

occupational pension schemes could

derive from the use of alternative invest-

ments could equally be applied to charities.

Contrary to popular thinking, many

hedge funds operate with an objective of

minimising the prospect of sustaining a

capital loss, regardless of broader market

conditions. Such strategies often focus on

arbitrage opportunities, or seeking to

exploit research findings at either the

corporate or macroeconomic level by

establishing 'covered' positions, which

limit the associated risk.

Fee structures are gradually being

scaled back and we are slowly moving

towards a culture where institutional

investors contemplating a sizeable invest-

ment should be able to negotiate a compet-

itive fee based on their funding level.

Meanwhile, considerable efforts

are being undertaken to improve

transparency, with more and more UK

hedge funds planning to adopt the

practice of many of their international

counterparts by appointing a chief

investment officer.

As well as being lowly correlated with

other investment vehicles and assets,

hedge funds have the ability to deliver

positive returns in rising and falling

markets, which makes them a great

diversifier and an attractive asset in

absolute terms. However, the problem for

charities is the difficulties that the trustees

face in trying to comprehend precisely

what the risk/reward trade-offs are.

Nevertheless, many investment houses

are now offering fund-of-hedge-fund

products which seek to blend hedge

fund strategies to provide potentially

superior investment returns with greatly

diminished risk.

Emerging market debt

For many years, investors have been

searching beyond the familiar frontiers of

domestic equities and bonds for asset

classes that might improve the risk and

return characteristics of their portfolios.

Until recently, though, few had been

prepared to diversify their fixed-interest

exposure to include holdings in emerging

market debt (EMD).

However, increasing allocations in

recent times are signs that the appetite

for EMD is beginning to change. This is

not surprising as the constituent countries

of the emerging markets universe

comprise 85% of the world's population,

76% of the world's land and two thirds of

the world's natural resources.

Nevertheless, the growth of EMD

as an asset class remains in its infancy.

The common perception is that the major

risk associated with an EMD portfolio is

volatility - the market price fluctuations

that encapsulate the foreign exchange,

interest-rate, political and economic

An investment alternative for charities HSBC Global Asset Management looks at the opportunities offered by alternative investments thatcharities should be considering

www.charitytimes.com www.charitytimes.com

For more information or an informal chat about our services, please contact Andrew Fletcher, Head of Charities on 020 7024 0306† / andrew.fletcher @hsbc.com or visit www.assetmanagement.hsbc.com/ukcharities† Calls may be monitored and/or recorded for security and service improvement purposes.