Advisers ‘spoiled for choice’ with alternative assets, correlation key

If we are truly honest about the state of the Australian investment industry when it comes to alternatives, we were very much a backwater for many years. That is, at least, at the mass market, retail, or wholesale level. For many years, the best alternative assets advisers could access were the so-called “black boxes” of expensive funds-of-hedge-funds.

Thankfully, this trend has changed significantly in the last few years, with advisers flooded with the entire periodic table of alternative assets. While certain high-profile, well-recognised sectors seem to gain all the media attention, think private equity and venture capital, there is a far more diverse range of opportunities below the surface.

Among the most popular with large pension funds and traditional wealth management practices are “real assets,” or those through which you own tangible assets. Examples are infrastructure, commodities, resources and of course, precious metals bullion. This sector has continued to expand with the additional of renewable and related energy assets, with the ultimate benefit being to gain access to a return stream all but guaranteed by government.

The natural next step is into ‘multi-asset’ strategies, which at their most simple resemble an old “balanced” fund, being able to invest across everything from bonds to equities, real assets and derivatives, all with the ultimate aim of delivering an absolute return. Among the more popular in recent years is the “tactical” or “dynamic” asset allocation strategy and the “risk parity” approach.

Taking on illiquidity has been a common theme in recent years, as the inflated valuations of bond and equity markets forced every investor to seek an edge wherever possible. Naturally, some of the best-performing alternatives fall within this sector, given the patient capital they offer a manager. Examples include private equity, distressed debt, venture capital, farmland and the uber-popular direct lending.

It may well be in the liquid alternatives sector where the greatest range of opportunities has arisen, primarily due to the evolving nature of the Australian investment landscape. The rationalisation of the financial advice industry has seen a flood of capital onto investment platforms, the majority of which require a minimum level of liquidity before advisers can harness the benefits of discretionary managed accounts.

Within this sector lies a range of investments spanning equity-like alternatives including long-short, event-driven, merger arbitrage and relative value. Then there is traditional global macro or trend-following hedge fund, which is seeing significant interest once again as advisers feel they have few places left to turn. And finally, we have digital assets, better known as cryptocurrencies, which are in the midst of one of the worst selloffs in their short history.

Ultimately, all these strategies have one thing in common: they promise non-correlated returns, and to deliver diversification to traditional bond- and equity-dominated portfolios in times of stress, such as today.

The big question, of course, is how well-prepared are they? It has become more important than ever for advisers to understand the role of every individual investment and how it has performed in different crises. As the saying goes, one crisis is never the same as the last. There are a long list of futures or systematic trading strategies that performed admirably during the GFC but failed to deliver in each subsequent selloff.

Similarly, there is the question of volatility. Should you be seeking a lower-volatility strategy? Are you comfortable with the fact that this likely means your potential upside is limited? And how much experience have the managers had — is their performance based on extensive back-testing or real-world results?

Moving to the illiquid options, the big question is whether the so-called “free kick,” being the illiquidity premium, will actually deliver the result that many expect. The flood of cheap capital has made it easier than ever for start-up companies to get funds, but how prepared are they and their investors for the difficult challenge of proving-up a market and delivering an operational business?

With a flood of competition and record levels of capital raisings, can private equity and venture capital continue to reach the 30 per cent target returns to which investors have become accustomed? And what impact will the massive selloff impacting the listed technology sector have on their mark-to-market or comparable valuations?

If you are as interested in the answers to all these questions as we are, attending The Inside Network’s industry leading Alternatives Symposium on February 23^rd to discuss these and many other issues may well be worth the time.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.