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Multi-manager View: Burning as bright a Tiger

As I write this, Tiger Woods has just carded a six under par total of 66 on the first day of the British Open at St Andrews and it made me think what he would have scored had he only been able to use his pitching wedge and putter rather than every club in his bag. I won’t bore you with the calculation but I think 85 would not be far off the mark. Now, that might be enough to beat most hackers around St Andrews but it certainly would not win him the Claret Jug.

There are parallels with this and portfolio construction. Traditional multi-asset portfolios consist of equities, bonds and cash. By including alternative asset classes such as private equity, hedge funds and property, we can reduce volatility and enhance returns. This is because, historically, returns from alternative asset classes have had a low correlation to returns from traditional asset classes and we expect this to continue.

Our favoured exposure to alternative asset classes over the past 12 months has been through private equity, which has grown rapidly over the last 10 years, with annual global commitments up from $18bn in 1990 to an estimated $70bn in 2003. Historically, growth in this asset class has been driven by the ability of top-performing private equity firms to generate returns that significantly outperform quoted markets over the medium to long term.

Private equity is a generic term for investments in private companies. It encompasses three broad categories – venture capital, which describes investments made at an early stage in a company’s life, development capital, which provides finance for the expansion of a company, and management buyouts, referring to the provision of funds to management for the acquisition of an existing business. In time, these investments are generally realised through a listing on the stock exchange or via a trade sale.

We access the asset class via London-listed private equity investment trusts, of which there are currently 18. Of these, we have invested in two of the higher quality management buyout specialists, Candover Investments and SVG Capital. These managed to avoid the technology bubble of the late 1990s and were able to participate in some very attractively priced deals during the subsequent bear market of 2000-02. Over five years to June 30, 2005, Candover Investments has returned 95.5 per cent while SVG Capital has returned 45.5 per cent. The FTSE All Share index is up by 0.6 per cent.

Of course, the most important consideration for investors is not how well the asset class has done in the past but what they might expect going forward. Short term, we do expect some headwind for the sector. One of the main reasons for the strong private equity market has been the availability of cheap debt, which has created a very positive environment for realisations. But current buying interest in private equity assets has made it more difficult for firms to acquire new investments at reasonable prices and cash levels have drifted up.

Share prices of many of trusts have risen to the point where they are trading at a substantial premium to their net asset value. We have viewed this as an opportune time to reduce our exposure and will look to reinvest when valuations are more reasonable.

Most of us can only dream of challenging Tiger Woods at St Andrews, even with the full set of clubs in our bag.

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