Investing Beyond the Mainstream: Alternatives

Australian Financial Review, October 2016

The phrase ‘alternative investments’ covers a broad church, but is perhaps more relevant to Australian investors now than it has been for many years. In an era in which mainstream debt and cash return little, and the outlook for Australian equities is uncertain, there is clear appeal in strategies that are different to the herd.

Hedge funds – a broad term in itself – are the most commonly used alternatives. One strategy under the hedge fund umbrella is called global macro. This involves a fund being able to take long and short positions – that is, benefit from an asset going up or down in price – across a range of asset classes from shares to interest rates, commodities and currencies.

Andrew Buchan, partner at HLB Mann Judd in Brisbane, favours the Winton Global Alpha fund, available in Australia through Macquarie. “It’s a good fund, with very little correlation to other markets – in fact, ideally it’s negatively correlated to Australian shares,” says Buchan. “It’s always our first port of call in the alternate space.” He also likes a fund called Aspect Diversified Futures, a similar offering available through Colonial First State, though he says it has slightly higher volatility.

“One thing we have learned from the Future Fund is the need to include alternates into a client’s asset allocation,” Buchan says. In addition to global macro he uses gold (most easily done through an ETF), currencies (usually the US dollar, again through an ETF), and private equity, though it is difficult to achieve exposure to. For this, Buchan uses the Ellerston Ventures Fund, originally the investment arm of the Packer family group. Despite the illiquidity that comes with venture capital – since the money has to stay invested for a long and unpredictable amount of time in order for the underlying investments to come good – Buchan thinks “that illiquidity margin is worth 3%, and that’s something you can’t ignore at the moment. You get a premium for the fact that you only get your money when the fund sells its investments.”

Not everyone is convinced. “We find it almost impossible to use private equity and venture capital in a portfolio,” says Paul Moran, financial planner at Moran Howlett in Carlton, Victoria. “We’d love to use it, but the liquidity requirements for individual clients’ portfolios make it difficult to commit to something that will be illiquid for some time.”

Instead, Moran favours some long-short funds, and in particular Antipodes Global Investment Partners, which was founded last year by Jacob Mitchell, formerly of Platinum Asset Management, another celebrated long-short manager. It offers long-short global and Asia funds. In an era where large cap stocks have been underperforming, “using a manager with the ability to short and long individual stocks within the market gives us the ability to add some value to a traditional large cap portfolio,” he says.

“We have a broad expectation that equities over time generate us 8 to 10%,” Moran says. “We don’t have any higher expectations of long-short, but they might more consistently produce 10% than is the case with the swings and roundabouts you get with long only.”

Ben James, financial planner at Scala Partners, thinks alternatives “are best described as an approach to investing rather than an asset class,” saying they do not necessarily offer superior returns or lower risk than equities or bonds, but that they have a differentiated risk/return outcome to the rest of a portfolio. “There is no specifically good or bad time to invest in alternatives,” he says, though today’s low interest environment is driving greater demand for alternatives.

His favoured managers include Wavestone Dynamic Australian Equity Fund and LHC Capital High Conviction in the Australian long-short space, and Ellerston Market Neutral and Bennelong Market Neutral. A market neutral fund is one that tries to minimize any correlation with market performance. There is more than one market neutral approach, but a common one is to look at the trading pattern of stocks which tend to revert to the mean over time. “This is a dispassionate approach where subjective judgement is secondary to the decision,” he says.

James Purvis is a member of the PHAROS investment committee, with which 46 financial planner practices are affiliated. He uses three funds he regards as alternatives. One is the Winton product also favoured by Buchan; another is AQR, a US-based operation which offers the AQR Wholesale Managed Futures Fund and Global Risk Premium Trust in Australia, among other things. The first of these is similar to the Winton product, investing in more than 100 global futures and similar instruments across multiple asset classes. Purvis also uses a global fund offered by PineBridge Investments, which in Australia offers the PineBridge Global Dynamic Asset Allocation Fund, which also invests across multiple asset classes. Purvis says the Winton fund can cost as much as 3% per annum when performance fees kick in, but that the performance of the fund merits the high cost.

Whereas Pharos is putting more into alternatives than it used to, Omniwealth is going the other way. “In January, we sold out of alternatives for our clients’ portfolios,” says Genene Wilson, senior financial planner; instead they shifted core investment strategies to indexing, via ETFs linked to real assets. It will be difficult for alternatives to play the same role in Omniwealth’s new strategy, as alternative ETFs tend to be synthetic rather than being backed by real assets (imagine the challenges of holding the physical assets underpinning an oil ETF, for example). There are exceptions – the BetaShares Gold Bullion ETF is backed by real gold in the London vault of JP Morgan Chase, for example – but they are reasonably rare.

Previously, Omniwealth had used products including the Ellerston Australian Market Neutral Fund mentioned by Ben James.

Wilson’s colleague Maria Dyson notes, though, “there is a place for investing in alternatives in most clients’ portfolios. However for the mainstream investor I wouldn’t allocate any more than 10% to alternatives.”