Much of The Alternative Answer will convey familiar information to those who have followed the quest for alpha over the years. Few regular readers of AllAboutAlpha, for example, will encounter with any sense of novelty the statement that hedge funds employ “dozens of different kinds of strategies” or that futures contracts don’t “provide an immediate ownership interest in an underlying asset.” That’s because the book isn’t written for the cognoscenti. This is a book-length sales pitch – or, rather, a sort of pre-sales pitch – aimed at those who neither run institutions nor count as high net worth individuals.
Beyond the Kids Menu
This book, then, is an appeal to the retail crowd, those Rice calls “typical investors,” passing along the good news that they are no longer “stuck with the children’s menu of investment options,” both because new products, liquid alternatives, have hit the market and because even the purveyors of some of the older alternative products, hedge funds and private equity funds, “are finding ways to offer their strategies to the merely affluent instead of just the superrich.”
Rice introduces that presumed reader to the major hedge fund strategies. This includes a concise (three paragraph) description of Elliott Associates’ efforts to get a pay-off on its Argentine bonds. It doesn’t take longer than that to acknowledge that “it’s a bit tough for judges in Manhattan to compel a treasurer in Buenos Ares to do much of anything” and along the way Rice offers an amusing description of Elliott’s “great global goose chase” looking for seizable assets outside the country such as the Libertad, the Argentine navy vessel that was held in dock in Ghana from early October into mid-December 2012 as security for these bonds.
In his discussion of private equity funds, Rice acknowledges the sort of overly clever “financial engineering” that has given the industry a bad name, and may have cost Mitt Romney a four-year lease on a place on Pennsylvania Avenue. Sometimes, indeed, PE firms do leverage a target company “to the absolute hilt,” Rice says, then “have to rob the future of the company to pay off the debt,” by for example cutting the company’s research and development budget, or licensing out core intellectual property, or getting the target company to pay them in dividends “any spare nickels they’ve otherwise missed.”
Nonetheless, Rice also says, the more typical case in the PE world is one of value creation – the new bosses can take a fresh look at the target firm’s operations and its markets, make necessary changes that the older bosses had resisted, and voila! Reap the rewards.
Potential investors will surely appreciate the warning that there are also times when PE performs a valuable service but fails to reap the rewards. Targets taken over by PE firms in the period leading up to the recent global financial crisis, the period starting in 2005, often benefitted. The new bosses saw what was coming and made necessary adjustments early. But the PE funds have never been rewarded for that, because of the drastic compression of the price-earnings ratio that the crisis itself brought.
Taken all-in-all, then, Rice is unenthusiastic about PE funds within a retail investor’s portfolio, although he observes that such funds can work well in stable market environments.
He is somewhat more enthusiastic about managed futures. He even spends a paragraph reproducing what he tells us is the standard chatter at the cocktail parties thrown by managed futures mavens. Immediately thereafter he helpfully explains that a CTA is not an “adviser” in the sense a retail investor might expect, and he offers a brief explanation of how a CTA is different from a CPO and how both are different from the older-style managed futures funds sold through brokerage networks.
For most investors who want exposure to this world, he concludes, the best route is through an actively managed mutual fund that specializes in such strategies and that aggregates the top CTAs.
Much in this book will prove instructive for the intended audience, and some of it will prove instructive even for those who might suspect they are too sophisticated and don’t belong in that audience.