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Alternatives cushion blows from market sell-off

Nicki Bourlioufas  |  21 Dec 2018Text size  Decrease  Increase  |  
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Market crash

Falling stock valuations and the return of volatility may prompt a rethink on absolute return

In the wake of a terrible October and further market volatility in 2019, alternatives may be worth considering.

Hedge funds or 'absolute return' funds, which aim for positive or less volatile returns in both rising and falling markets are key examples, alongside private equity or early stage equity investments, commercial mortgages, property and infrastructure.

Rob Holder, an asset allocation specialist with Crestone Wealth Management, says at this late stage of the equity market cycle, returns from traditional asset classes are expected to be “relatively muted in the period ahead, meaning that alternative assets can deliver attractive returns while helping to mitigate risk in a volatile environment.” In response, he recommends investors adopt a neutral equities weighting, but adopt an overweight position on alternatives.

Holder recommends a fund structure as the most "realistic" option for individual investors.
“With such a diverse range of assets comes a wide range of risk and return expectations, with a diversified fund of hedge funds one of the lower risk options and private equity and venture capital at the other end of the risk/return scale,” he says.

James Ridley, a financial planner with Atlas Wealth Management, says the level of allocation to alternatives will depend on a range of factors such as how risk-averse an investor is and their timeframe. “Generally, an investor who ranges from being a balanced to high growth investor will target alternatives [investments] directly ranging from 5 per cent to 20 per cent,” he says.

Becoming mainstream

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Andrew Lord, director at wealth management firm Sherbrook Private, says investors’ asset allocators have been slow to adopt alternative assets. But what was once considered a risky, obscure investment is fast becoming mainstream.

“The most independent organisation in Australia, the Future Fund, has 31 per cent allocated to equities, 7 per cent to property and 14.4 per cent to cash. So, they allocate 47.6 per cent to alternatives or illiquid assets.

"This property allocation is heavily slanted toward illiquid real assets rather than shares, so [alternatives allocation] really is greater than 50 per cent of their portfolio,” says Lord.

Sherbrook runs individual client portfolios with as little as 10 per cent to 20 per cent in listed assets and cash, and the balance, or the majority of the portfolio, is in alternatives. It can also access hedge funds that may have minimum investments of $1 million-plus by combining clients’ funds through special purpose vehicles to achieve the minimum investment required.

He highlights solid return figures of 12.7 per cent per annum, averaged over seven years, and with zero defaults, and a duration of six months to two years. Its debt investments haven’t only been restricted to property, but also peer-to-peer, livestock lending, disbursement funding and unlisted corporate credit to get a spread, says Lord.

“These high-yielding cash-distributing securities that produce total returns greater than equities and property have allowed us to then deploy capital to real businesses that may not be listed but are quarter the price of a similar listed company.

"These assets include agriculture assets, hotels, US multi-family housing and US aged care, land subdivision up to 10-year timeframe, and diagnostic life science companies," Lord says.

Growing up

Some alternative investments are illiquid and may require some time to achieve the desired returns. For example, a large investment in a private equity fund may have a seven-year-plus lock-up period, which may not suit an investor with significant liquidity requirements.

“Alternative assets are often, although not always, less liquid than traditional assets, and this is an important consideration,” says Holder. So, investors may need to be prepared to hold such investments for the longer term.

However, Lord says this isn’t always the case. Some assets have a set term, such as mortgage backed securities which may mature over one or two years, or hedge funds that may have monthly redemptions. Here, investors have been able to access their capital without sacrificing returns. But illiquidity also has its benefits, says Lord.

“As clients have become more understanding with the lack of liquidity, they now appreciate that it reduces the volatility and risk in the portfolio. A major part of the portfolio isn’t reliant on the fear or greed of the previous day."

 

is a Morningstar contributor.

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