Alternative Thinking: Diversifying Beyond Traditional Asset Classes
By Robert Wright /November 28,2022/
Once a staple investment allocation, the traditional balanced portfolio of shares and bonds has had some challenges in delivering positive returns in today’s market environment.
Institutional investors, such as superannuation funds and endowments have been investing in alternatives for many years and it is a rapidly growing asset class in the global investing landscape. Individual investors are now looking to alternative asset classes to help diversify their portfolios and improve the probability of meeting their long-term objectives.
What are alternative assets?
Alternatives cover a broad range of asset types, which can include almost anything that does not fit into traditional, market-traded equity and bond securities. These include assets such as real estate, infrastructure, shares in private companies, private loans and debt, as well as alternative trading strategies, such as hedge funds and absolute return funds.
Each of these sub-categories can have very different risk and return drivers to each other as well as to traditional equities and bonds. By including an allocation to these asset classes, the diversification benefit can improve the expected risk-adjusted returns of the portfolio as a whole.
It is important to note that these asset classes are less liquid and more complex than traditional equities and bonds. Whilst it’s expected to generate additional returns or better risk outcomes for investors; the illiquid and private nature of many alternative assets generally suit investors with a longer investment time horizon.
We consider them appropriate for investors with a minimum investment horizon of five years and recommend a moderate portfolio allocation of 5-20% depending on the investment objectives of the portfolio.
Not all alternatives are the same
For most investors, a diversified allocation covering a wide range of alternatives can lead to better outcomes over the longer term. Illiquid or private assets mean that investment managers can take advantage of inefficiency or less transparent asset prices to generate more skill-based, idiosyncratic returns.
Conservative or more cash-flow based valuations can provide more portfolio stability and less sentiment driven ‘noise’ compared to the daily ‘mark-to-market’ price returns in equity and bond markets.
Alternative trading strategies can generate returns, even when markets are declining in value, by selling stocks ‘short’ or using other types of derivative instruments. Overall, these assets and funds can contribute to better returns, reduce volatility and build in more downside risk protection for portfolios.
The right mix and allocation of alternatives will vary, and the benefits of these asset classes also come with a different set of risks to consider which may not be suitable for all investors.
What alternative assets bring to your super investment mix
By Robert Wright /November 17,2021/
Most of us have heard of the main asset classes: shares, property, fixed interest and cash, but alternative assets are less well known. However, these types of assets can provide further diversification and enhanced returns for your super.
Alternative investments are those found outside the traditional asset classes. Typical ones include real estate, private equity, venture capital, infrastructure, renewable energy, hedge funds, commodities, and private debt.
Generally, these are assets that aren’t correlated to the performance of the sharemarket, that is they can often perform when sharemarket returns are down or flat.
The net result is that alternative investments add an extra layer of diversification – you’re not ‘putting all of your eggs in one basket’ and seeing all asset class suffer at the same time.
Low returns pique interest in alternatives
In the current low interest rate environment, which tends to mean lower returns for cash and bonds, alternative investments can help members grow their super to retire comfortably.
Alternative investments differ to publicly available funds as they’re part of the private investment market and aren’t easily accessible for individual investors. They typically include:
Infrastructure assets are known for providing long-term, stable and predictable cash flows. Opportunities can be found within energy production and transmission but are also emerging in newer sectors such as agriculture infrastructure and renewable energy, particularly wind-powered energy and a selection of solar-power opportunities.
The private equity sector invests in companies that are not publicly traded. The advantage is that by investing at the start of a company’s lifecycle, it’s possible to generate strong risk-adjusted returns and benefit from high earnings growth when compared to listed markets.
Real estate has a low correlation to shares but is often considered to be a good hedge against inflation. The asset class has evolved over time to include publicly listed and real estate investment trusts (REITs) that include data centres, childcare and storage facilities, as well as commercial real estate debt, which provides loans to commercial borrowers who need funding for real estate purposes.
Performance can lift when using alternative assets because alternatives are generally less impacted by daily market movements in the way that other assets are. Shares and bonds can be quickly affected by changing market, social and economic events, such as the COVID-19 pandemic for example. Therefore, the overall volatility, or the ‘roller-coaster ride’ of increasing and decreasing valuations, should reduce when funds include a proportion of alternative assets in the mix.
Not all alternatives are equal
Of course, alternative assets need to be carefully researched and reviewed in order to find the most appropriate options for each particular fund. They need to be carefully weighed up against other asset classes and sectors to ensure the most appropriate levels of risk and reward that will support investors to achieve a comfortable retirement.