What is wrong with alternatives?

As investors seek secondary ways to supplement their income beyond the traditional bond and equities options, they have found an answer in the Australian alternatives market, which has reached more than US$275 billion in size.

The figure makes Australia the fourth-largest alternatives market in the world, according to Austrade, although there is still a way to go before it reaches the size of world leader North America at US$3.7 trillion. It is also a fraction of the size of the Australian equity market which is over US$685 billion. 

Austrade said: “Australia’s alternative investment industry is substantial and its outlook for growth is promising during periods of financial market volatility and economic uncertainty around the globe. 

“One of the important features of alternative investments is their ability to help manage volatility and preserve capital in a diversified portfolio. In other words, the attraction of these investments is increased diversification and returns and/or reduced risk.”

The demand for alternatives is growing thanks to interest by pensions funds, by high net worth investors who hold them in their self-managed super funds (SMSFs) and as other asset classes become more expensive. It is also helped by ongoing fears of a market downturn caused by geopolitical issues such as the US/China trade war. 

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WHAT IS CLASSED AS AN ALTERNATIVE?

Alternatives cover a wide range of assets; the ACS Alternatives sector includes long/short funds, managed futures, micro-caps, absolute return and commodities. Separately, the term can cover physical assets such as art, cars and wine which are brought directly rather than via a managed fund. 

This wide breadth of asset types makes it difficult to make comparisons between them, for example, when looking at the ACS Alternative sector, this contains 163 funds and has lost on average 0.01 per cent over one year to 24 June, according to FE Analytics. But when you drill down into looking at the individual funds, returns vary from losses of 24 per cent for the Tribeca Global Natural Resources fund to gains of 21 per cent for the Enlihtan Global Opportunity Single fund.  

Scott Haslem, chief investment officer at Crestone Wealth Management, said: “One issue we find with alternatives is most are skills-based strategies so you get more manager return dispersion between the best and worst-performing funds. The range of outcomes is wider than you’d find for equities and fixed income.”

Table 1: Main pros and cons of alternative investments

In light of pros and cons of alternatives outlined in table one, investors need to be careful when considering the asset class and only hold them as a portion of their portfolio to avoid single asset risk. 

Jean Christophe de Beaulieu, head of investments for Australia at Acadian Asset Management, said: “I would avoid holding more than 20 per cent in alternatives, it should play a role alongside bonds and equities rather than being held as a single exposure.”

While fees can be high for these types of funds, they have been coming down more recently thanks to wider industry pressure on fund pricing which has seen some move from 2/20 per cent to 1/10 per cent. However, one area to still monitor is the watermark when the performance fee kicks in as this should only be once a suitable period of outperformance has been achieved rather than just returning above the market. 

CRYPTOCURRENCY

A newer type of alternative investment that has emerged recently is cryptocurrency such as Bitcoin. Bitcoin was originally developed as a decentralised global payment system back in 2009 but has evolved into being bought and sold in large quantities for investment purposes. 

As of 24 June, one Bitcoin equals $15,350 but it peaked as high as $25,709 in December 2017, in Australian dollar terms. 

But the Australian Securities and Investments Commission (ASIC) describes cryptocurrency as being highly speculative and leaving investors at risk of losses. 

“The exchange platform on which you buy and sell digital currencies are not regulated, so if the platform fails or is hacked, you will not be protected and will have no legal recourse. Cryptocurrency failures in the past have lost investors significant amounts of real money,” it said.

“A cryptocurrency is not guaranteed by any bank or government. Its value is based on popularity at a given time, which is influenced by factors such as numbers of people using it, the ease with which it can be traded or used and the perceived value of currency and its underlying blockchain technology. Investing in virtual currencies is considered highly speculative, as values can fluctuate significantly over short periods of time.”

This was echoed by de Beaulieu who said his firm had researched the asset but struggled to find sufficient evidence to make it worth investing. 

“Crypto is tricky as it has little economic underpinning. We did some work on Bitcoin and it was very hard to find statistically robust evidence so we would not recommend making a large allocation to crypto as it is highly volatile and hard to forecast its movement,” he said.

HOLDING COLLECTABLES

For those holding SMSFs, one method of supplementing these is the purchase of investments such as art, wine and cars which are known as ‘collectables and personal use assets’. According to the Australian Taxation Office, around $366 million is held in these type of assets but this represents only a 0.05 percentage of total SMSF assets.

Assets must be held with the intention of providing future retirement rather than present day benefits, must have a documented investment strategy, must be insured and cannot be stored in the private residence of any related party. When it comes to be sold, the asset price must be determined by a professional, independent valuer. 

However, single risk is high for these type of assets, valuations are highly correlated to market sentiment and markets are less liquid and transparent. 

The Australian Shareholders Association cautions: “It is important not to get caught up in marketable stories of immense wealth generated from a single asset. For every Ferrari 250 GTO, there are 100 Leyland P76s.”

FUTURE OF ALTERNATIVES

There is no question alternatives are a growing part of the investment market and this is likely to continue over the next five years as newer products come to market. This includes those targeting retail investors such as Pengana, which launched a global private equity listed investment trust in April, and Metrics which runs a variety of products covering areas including private debt and real estate debt.

John O’Keeffe, head of boutique strategy at Fidante, said: “We are seeing listed investment companies and listed investment trusts who are offering access to underlying real estate, infrastructure and private equity as a way for investors to access things that had previously been difficult. That is definitely a pitch to the retail market and it will grow over the next five to ten years.”

de Beaulieu said the timing for growth was prescient as the long-term valuations of other assets were reaching extreme valuation territory. 

“It is hard to find a place where you have confidence it will generate returns over the next five to 10 years so people are thinking outside of these traditional asset classes as they are all getting expensive.”

According to a global alternatives report by Joachim Klement, head of investment research at Fidante, the future annual growth rate of alternative investments should average 15.7 per cent over the next three years globally.  

“Most of the growth is forecast to occur in private markets with infrastructure and private debt investments showing annual growth rates of 38.6 per cent and 22.8 per cent respectively, and property investment not far behind. Hedge funds and natural resources investments in private markets are expected to be laggards over the coming three years.”

For retail investors who were considering the asset class, Haslem said there were several factors for them to first consider which might not apply to traditional investments.

“The challenge for retail investors is to understand what you are investing in, what your motivation is for investing in alternatives, what the risk/return profile is and the liquidity of the asset. Manager selection is also important as there is more dispersion in manager returns.”

“They should also remember a cheap fee does not mean a fund is good or bad and nor does having a high fee indicate quality,” added de Beaulieu.