'FINANCIAL repression" - the predicament of no-risk, no-return - is helping to perk up interest in alternative investments, particularly strategies that can take advantage of trends and sharp volatility shifts, says Permal chairman and chief executive Isaac Souede.
This, he adds, is creating distortions in markets that investors can take advantage of - particularly if you have a long-term view and are willing to give up some liquidity for a long-term potential gain.
Permal is among the world's largest fund of hedge fund groups, with assets under management of about US$20 billion.
Says Mr Souede: "Financial repression links to why what we do is becoming popular. It means if you take no risk, you earn no money from a long perspective... If I can make 4 to 5 per cent with a high degree of conviction and very little odds of a large drawdown, say through a macro strategy, that sounds appealing."
Hedge Fund Research data shows that monies continue to be allocated into hedge funds this year, thanks to investor appetite for strategies that are not highly correlated with equity markets. In the second quarter, investors allocated US$4 billion in net new capital to hedge funds, bringing net inflows in the first half to US$20 billion. This is despite most strategies' underperformance relative to conventional markets. In the year-to-date, the HFRI Fund Weighted Composite Index returned around 1.8 per cent, compared with the S&P 500's 9 per cent. Most of the recent inflows into Permal, says Mr Souede, has come from institutions.
Permal, he says, is "pro-US equity" and also "reasonably bullish" about China. Those two countries are virtually the main engines of global growth, reflecting a "G2 world''. In particular, growth in Asia and the emerging markets is now closely linked to China.
"Assuming a resolution of the fiscal cliff, we're pro-US equity especially (stocks) that have yields that are interesting and can continue to grow their yields. Sooner or later there will be a reallocation to equity from fixed income," he says.
Some 60 per cent of stocks in the S&P500 now yield more than 10-year Treasuries, where yields are now just under 1.5 per cent.
The bright spots in the US include a manufacturing "renaissance" and a recovery in the housing sector. In manufacturing, US labour rates have become competitive. This is expected to improve unemployment numbers particularly among those without college degrees. Banking has also strengthened.
China, he says, has extended bear markets and short bull markets. "When it's going to be a bull market, you need to be there to take advantage of it, but you need to be protected for the long term."
Mr Souede expects the Chinese government to launch a stimulus package of US$2 trillion, which is likely to be channelled into consumption and the environment.
He believes the last decade's bull market in sovereign bonds is unlikely to be repeated, unless the investment outlook worsens markedly. "If you tell me that the US will be in recession, China in a hard landing, then that asset class will win again. But it will be a very sad world."
Permal's fixed income exposure is currently half in credits and half in non-credits. "In the high yield area, assuming we don't have a global recession, and we're in a world of financial repression, you are still paid for the risk you take."
The group at the moment is "lightly invested" in emerging debt due to inflation concerns, but that may soon change. The last few months have seen a sell-off in some emerging currencies, such as the Brazilian real and Indian rupee.
"For us there is finally an opportunity in local currency debt because there is less currency risk ... We may well increase exposure to those instruments because you can win on currency and yields are attractive."
Gold is also a theme in Permal portfolios, but mainly through equities where valuations are more attractive than physical gold. A thousand dollars, says Mr Souede, will buy two-thirds of an ounce of gold. "If you bought blue-chip gold companies such as Barrick Gold and Newmont Mining, doing the math on the US$1,000, you'd have about two ounces of gold. If you then went to smaller exploration companies, you'd have four ounces. That doesn't mean the arbitrage closes immediately, but over time it's pretty clear where you want to be."
Some gold companies, such as Barrick, are also paying a dividend of between 2 and 3 per cent, unlike physical gold that offers no yield. "Bullion is now in a trading range. If you believe that in the medium term of 18 to 24 months, the powers that be in the Federal Reserve and the ECB prefer inflation to deflation, you could see gold resuming its upward rise ... Bullion at this point needs to see inflation because dollar strength is not good for it."
Exposure to Asian equity, at the moment, is obtained through China, which is seen as pivotal to Asia's fortunes. "If I'm wrong and China has a hard landing, all of Asia won't grow ... Most countries in Asia (except India) are in the glide path of a pro-growth policy ... which is very positive for equities. But the harbinger of all that is China. By September we can be more directional. Right now, China works or it doesn't work."
On Europe, he believes, the challenge is to contain the crisis. "If Europe stays on a glide path of zero growth for the next five years, US and China will be fine ... As long as Europe doesn't become cataclysmic and create a global financial issue, then it can be at least cauterised. Europe is a very long-term, trial-and-error solution. The key is for the US and China not to implode."