The role of alternatives in multi-asset portfolios
Alternative investments access a broader universe of assets that are outside traditional asset classes such as equities and bonds. These investments can include direct assets, such as private equity, real estate and agriculture.
This asset class is a very useful diversification tool in a broader SMSF portfolio because investments within it have low to moderate correlation to stocks and bonds. However, direct assets are also illiquid, which means they are relatively more difficult to sell compared to assets traded on a stock exchange for example, and sometimes require capital to be locked up for a long time.
Alternative strategies are a second broad subset of investments is this class that also derive their returns by profiting from the inefficiencies in capital markets.
These strategies include hedge and absolute return funds, which seek to capitalise on the mispricing of assets relative to each other. Returns are often dependent on the skill of the manager, rather than the direction of the broader market. Absolute return strategies aim to produce consistent outperformance, with returns not driven by broad market movements.
Alternative investments’ role in multi-asset portfolios is to improve the overall risk/return profile. They fulfil a number of vital functions:
- They broaden the potential for returns from a limited set of traditional asset classes to a much wider set of non-traditional assets, such as agricultural land or businesses, infrastructure or private equity. This is important for the robustness of portfolio returns and increasingly important in the current environment where bonds are expensive and equities’ valuations appear stretched.
- They diversify a portfolio away from market risk towards strategies that are more reliant on investment skill.
- They can benefit from market volatility through allowing faster-moving capital to respond to market dislocations. Well-designed alternative strategies benefit by being liquidity providers in times of market stress, rather than being victims of market corrections.
- They can help the portfolio adapt to changing market environments. Managed futures, for example, are designed to benefit from extreme market moves in either direction.
An allocation to alternatives can help multi-asset portfolios achieve their target returns with lower overall volatility and exposure to the risk of extreme losses, which is critical for investors in or near retirement. Adding alternative sources of return can help deliver a smoother, long-term return path.
What to consider before investing
As with all investments, there are risks SMSF investors need to consider before allocating funds to alternative strategies.
Returns are not guaranteed
When you invest in a managed investment scheme, you should be aware that returns are not guaranteed. Future returns may differ from past returns, the level of returns may vary, the value of the investment may vary, and there may be the risk investors will lose invested capital.
Many alternative strategy funds invest in securities that are listed on share markets around the world. This means fund performance can be affected by risks these securities face.
Credit and liquidity risks
Traditional risks such as credit and liquidity risk can be magnified for alternative assets.
Investors braving financial markets have faced the most challenging conditions in decades as weak global economic growth eats into returns and shows few signs of picking up to any meaningful degree.
Higher share market volatility has also made markets difficult to navigate, and even advisers who successfully guide their clients through a growing number of challenges may find clients’ returns less than adequate. Furthermore, AMP Capital’s view is that markets will remain volatile at least until the end of the year, which can create a less-than-ideal scenario for stable returns.
Alternative investments and strategies may assist investors in retirement, as well as others with shorter time horizons. For example, dynamic asset allocation can provide a more flexible approach by actively navigating the ups and downs of market cycles. As noted, alternative sources of return outside equities and fixed interest can diversify risk and offer more stable returns.
Investors face a growing range of challenges in achieving a comfortable retirement. Which is why now is an opportune time to explore alternative sources of return, which can offer diversification, relatively low volatility and active management during this part of the market cycle.
Access up to 80 global opportunities in a single trade
In a world where market volatility and low growth are the new norm, asset allocation is more important than ever. However accessing asset classes globally and outside of the usual places in order to do this is difficult.<
AMP Capital’s Dynamic Markets Fund (Hedge Fund) ASX Code: DMKT, an exchange traded managed fund, offers a low cost solution to global portfolio diversification with a real return objective.