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23 April 2024

Non-traditional assets could do well in 2009


By Shuchita Kapur

As financial crisis deepens by the day, the policy of diversification becomes all the more vital. Swiss Bank UBS dwells on some non-traditional asset classes in its new report and believes diversification benefits of these assets should hold in 2009.

The bank is the least bullish on listed real estate and does not expect recovery this year. On commodities, the bank predicts a modest rebound this year but sees no bull run.

It sees opportunities in private equity and believes that despite some major new operational constraints, the financial market sell-off may soon prove positive for nimble private equity firms.

Coming to hedge funds, the bank sees a year of transition and consolidation after suffering majorly in 2008. Here is a breakdown on what investors can expect in all these asset classes in the coming year.


According to UBS, listed real estate market is expected to remain weak this year as well despite the sharp declines that was witnessed. As far as unlisted market (real estate investments that are not traded on an exchange), UBS expects prices to continue to fall in all major regions, and recovery is not in hindsight before 2010.

"To some degree, the deep discount of the listed real estate market relative to the net asset value [NAV] already reflects market expectations for further erosion in prices of the underlying properties. Nonetheless, we believe listed real estate prices will continue to decline in 2009," says the report.

For rental revenue growth in 2009, UBS estimates are still too positive in light of the unfolding global recession. "Despite the benefits of lower interest rates, tight credit conditions will continue to aggravate refinancing conditions for property developers and Real Estate Investment Trusts, or Reits. In addition to overcapacities in certain countries, like the UK, Spain and Ireland, we expect rental incomes at retail and office properties to stagnate, or even fall, as demand for floor space declines," it adds.

The real estate scene seems quite varied as we move from one region to the other in Europe. UBS foresees areas of substantial weakness and downside risks that are quite varied. In Europe, property investments in Switzerland and Germany were more reasonable and less leveraged in recent years, unlike in Spain and Ireland, where high investment resulted in an overheated real estate market, it points out.

Countries facing overcapacity may face a decline in rental income growth beyond 2009, impacting negatively the intrinsic value of properties in those markets. Moreover, too much dependence of the real estate on the financial sector is another disadvantage in the current scenario. UK listed real estate market is a stark example here. Its over reliance on the financial sector, which is undergoing major structural change amid an overall recession, is a drawback. Thus, the UK commercial property prices are expected to decline further, with additional losses likely for the listed market.

Coming to Australasia (region which saw substantial declines in 2008), UBS expects further price declines of unlisted properties to a large extent. Nevertheless, the Swiss bank continues to remain cautious as long as the fundamental outlook continues to deteriorate. For the commercial real estate market in the US, UBS sees increased downside risk for the retail and office segments, as household and corporate balance sheets correct and compound the weakness in the broad economy.


UBS is more bullish on commodities (the other non-traditional asset discussed in the report). As per the estimates of UBS, prices should pick up in late 2009 and expects a modest increase in cyclically depressed commodity prices once economic weakness starts to fade. However, a boom is unlikely and UBS hinges just on a modest upturn in commodity prices.

"Commodities extended their strong rally into the first half of 2008 thanks to robust demand from fast-growing emerging market economies and continued supply constraints. But the bull market quickly reversed course as the global economy weakened and the focus shifted from supply bottlenecks to flagging demand. Since their peak in early July 2008, broad commodity indices have fallen more than 30 per cent in USD terms," the report says.

On the back of fluctuations and drops seen last year, UBS sees commodity to remain weak in 2009. "Demand for commodities has plainly weakened, and we expect most commodity prices to remain under pressure during the first half of 2009, especially for base metals. Meanwhile, inventories are likely to continue to grow. In our view, supply cutbacks will not be meaningful enough to slow the build-up of inventories during the first quarter of 2009," it says.

"Therefore, we think that investors should maintain a reduced exposure to commodities as we enter 2009. Despite depressed prices, we think it is premature for investors to begin building up long-term commodity positions," it states.

However, the collapse in capital spending to expand supplies and the sharp drop in net long futures positions will likely support commodity prices when the economy begins to recover. UBS' positive take on emerging markets supports commodities.

"We think emerging markets are in good shape to weather the weak economic environment. The increased weight of emerging markets in the global demand for commodities, albeit largely used for exports, should buffer the worst effects of the recession on commodity prices, in our view. That said, US consumption is in sharp decline, which should limit the price recovery."

Thus, only a modest upturn in commodity prices is expected during 2009 and not the emergence of a new bull market. On oil prices, UBS predicts crude to again retest the $85-barrel level toward the end of 2009. "However, we would not exclude the potential for temporary setbacks. We look for little change in global crude oil consumption from 2008 to 2009, and we assume that the marginal production costs of unconventional crude oil will hover around $80/barrel.

"We note that numerous factors could undermine our forecast, such as sub-trend growth in 2010, weak crude oil demand from emerging markets, and a sharp increase in spare capacity," the report says.

Gold, an asset that outperforms other commodities and asset classes during periods of heightened risk aversion, may not give big return now and is likely to remain stable. "With inflation declining and the USD strengthening, at least in the near term, a stable gold price is already an achievement. In our view, gold runs the risk of weakening when risk aversion normalises."


As far as hedge funds are concerned, UBS sees many transitions and consolidations happening this year, which could see the structure of some hedge fund styles.

Last year, most hedge funds lost money, while performance varied by style. It would not be wrong to say that hedge funds posted their worst performance last year since 1990. However, as a group, they outperformed higher-risk assets, such as global equities and high-yield bonds.

Going forward, the first of many issues that the hedge fund industry will grapple with is how to cater to its heterogeneous client base.

In recent years, the client base has grown from the traditional institutional and high net worth investors to include a much broader range of clients. UBS expects some clients, dissatisfied with performance and limited liquidity, will withdraw their money. This will bring additional consolidation in terms of the number of funds and assets under management, which will also assuage concerns that too many managers chase too few opportunities.

Moreover, regulators may also force some further changes. Even if short-selling bans are lifted, hedge funds will become more cautious when shorting the stocks of certain industries. If bank solvency rules are tightened and capital charges for prime-broking operations rise, lending to hedge funds will remain expensive.

Resultantly, this will pressurise strategies with low margins and high leverage. In this light, USB believes the structure of some hedge fund styles is likely to change.


In the case of private equity, the Swiss bank sees opportunities arising. Despite some major new operational constraints, the financial market sell-off may soon prove positive for nimble private equity firms, it says.

Like other assets, private equity market too suffered in 2008. Although the financial market selloff will likely create longer-term investment opportunities, the broad, immediate impact of the crisis has been decidedly negative. Private equity funds are constrained in their ability to unwind profitable investments through initial public offerings and corporate sales, which may weigh on returns for some managers.

Restrictive lending standards will continue to limit activity, primarily in the leveraged buyout market. In this segment, only conservatively structured, smaller deals with higher equity levels are finding financing.

However, there is a sliver lining for PE in all this turmoil. Periods of economic weakness and bearish sentiment have historically created the best buyout vintages.

Depressed valuations serve to lower entry prices, and operational turnarounds can be implemented more rigorously. And the premium reaped for the investor's willingness to forgo liquidity, typically for 10 to 15 years, can be particularly high in such environments, says UBS.

Tightened credit availability has only had a limited impact on venture capital, since this area relies least on leverage. Some private equity segments may even profit from constrained credit conditions, says UBS.

"For example, distressed debt funds and mezzanine financing, which inject capital between debt and equity, will likely play a more prominent role as corporations seek to adjust their balance sheets. The value drivers across private equity strategies differ greatly, and each will contribute at different points in the business cycle. Therefore, diversification across strategies, regions and vintages remains critical," the report adds.