And now for something completely different

Investors are growing wary of conventional assets and are looking for alternatives that are less susceptible to wild market swings

The family home makes up 44 per cent of the wealth of Australian households, the Australian Bureau of Statistics reports. Investment properties comprise 14 per cent, cash and shares 4 per cent each and superannuation – which in Australia usually means 75 per cent shares and property, 25 per cent cash and bonds – a further 13 per cent.

However, investors are growing restive about the over-representation of these conventional assets in their portfolios and the under-representation of alternatives: precious metals, commodities, private equity, hedge funds and art.

The reasons are many: six interest rate rises since October 2009 in the case of property; the stop-start recovery of the global economy for shares; the European debt crisis for bonds; the threat of inflation in the case of cash. And they add up to a singular shift into what are unfamiliar asset classes to most investors.

During the global financial crisis, the prices of alternative assets either moved in the opposite direction to those of crashing shares and corporate bonds, or did not fall as far, says Nicole Connolly, Asia-Pacific director of alternative investments at Russell Investments.

“Alternatives have proved their role as portfolio diversifiers and risk mitigators in volatile markets,” she says.

As well as dampening swings in portfolio returns in wilder markets, alternative assets promise higher returns, although with less certainty, in calmer times.

However, the fact that since the start of the year the Australian sharemarket has matched three monthly increases with the same number of monthly falls suggests the crisis may have destabilised the market indefinitely.

Van Eyk Research chief executive Mark Thomas believes sharemarkets could track sideways for several decades but with wild swings from year to year.

“The single most important thing is not to rely on the direction of equity markets as your source of return,” Thomas says. “In a period of volatility and a sideways-moving trend, you are going to end up with a big zero.

“You have to ask yourself: ‘How do I supplement that strategy with other strategies, without forgoing the opportunity if equity markets were to start trending upwards again?’”

Van Eyk’s answer, set out in its latest strategic asset allocation recommendations, includes devoting 20 per cent of a balanced portfolio to alternative assets.

Even economists are unsure as to which is the likelier – inflation (rising prices) or deflation (falling prices). Alternative assets can protect investors’ money from both menaces.

“If you are entering a period of high inflation, private equity, infrastructure and property, being real assets, should provide investors with protection from a high-inflationary environment,” Connolly says.

Similarly, deflation is “not great” for equities, says James Wright, the chief investment officer of asset strategies and alternatives at ING Investment Management, “with lots of pressure on margins and people holding off their consumption purchases because they think prices are going lower”.

Asset managers are responding to investor enthusiasm with new products that address the two main objections to alternative investments: high fees and low liquidity (that is, ease of buying and selling).

The rise of exchange-traded commodities (ETCs are pooled investments that trade on the Australian Securities Exchange and other exchanges) has made investing in gold, silver, platinum and palladium as easy as buying Rio Tinto shares. ETCs, together with listed funds for infrastructure, private equity and hedge funds, simultaneously decrease the cost and increase the liquidity of alternative assets.

Unlisted funds previously reserved for superannuation funds and other big investors are also beginning to open up to individual investors. For example, Macquarie, along with RARE Infrastructure, AMP Capital, Colonial First State and Lazard, operates unlisted infrastructure funds open to investors with $50,000 or less to invest. Analysts caution that not all infrastructure funds, let alone hedge funds and commodities, are alike.

For example, crude oil, copper and iron ore are the commodities most in demand when the world’s factories are at full tilt. The prices of these important commodities hit 20-month highs in April but have since shed 20 per cent as hopes of a global recovery gave way to European debt woes and weak demand outside China.

By contrast, gold tends to benefit from idle factories and ships as investors look for havens protected from sideways-moving sharemarkets. Accordingly, global economic wobbles sent the gold price to a record high of $US1265.30 in June – the precious metal rose 34.1 per cent in the 12 months to July 1.

Any protection provided by alternative assets, it seems, will come at a price – in the form of a steep learning curve for investors to climb.

Alternative asset classes

BRW

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