How you can use listed products to enhance returns and lower your volatility

Uncertainty and volatility are part and parcel of investing, but there are a range of ways you can manage these in your portfolio. One option emerging in popularity is called alternative investments. 

Alternative investments are a range of assets that are designed to perform differently to equities or fixed income. These include private equity, private debt, hedge funds, real estate, infrastructure, commodities, collectibles, structure products and of course, cryptocurrencies.

In this wire, I'll explore the options, along with the research to support using alternatives in your portfolio.

Watch the video or read the written version of the explainer below.

Why use alternative investments?

Diversification is often called finance’s only free lunch and it helps spread your returns and risks in your portfolio. Using different assets that perform differently to each other (that is, have low correlations to each other) is one part of diversifying your portfolio. Alternative investments tend to have low correlations to traditional assets. In this chart, you can see gold, commodities, real estate and bitcoin compared to shares and bonds. For example, if international shares were to move 1% over a period, gold would typically move only 0.31%.

There is some research to back using alternative investments. This study from JP Morgan used a 20% allocation to alternative investments as an example, and found it improved returns for volatility in an aggressive portfolio, reduced volatility and improved returns in a balanced portfolio, and reduced risk in a conservative portfolio.

A study from UBS had similar results – and chances are, your super fund has had a decent allocation to alternatives for some time. So there’s a good reason to think about alternatives but here’s where it gets tricky. Alternative investments are often those assets which can be difficult for everyday investors like you or me to get access to, be it because of pricing (not sure if you have a spare $97,000 to pop in bitcoin) or a range of other reasons.

That’s where listed products come in. There are 143 ETFs, Listed investment Vehicles and REITs that can help you. At this stage, you won’t find collectibles like cars or jewellery but who knows what the next few years will bring.

Before we start, it’s worth pointing out that certain types of assets suit certain structures. For example, if you look at options like real assets, private equity or private credit – these are more illiquid assets requiring large-scale investment, and your options are more likely to be Listed Investment Vehicles (which includes Listed Investment Companies (LICs) and Listed Investment Trusts (LITs)).

When it comes to assets like commodities or cryptocurrencies which can be more liquid to trade, ETFs are usually able to accommodate. For hedge funds, it’s a mix and depends on the choice of the issuing manager as to what structure they’ve picked.

We’ll start with commodities and cryptocurrencies because they have some similarities.

When you invest in a commodity or a cryptocurrency ETF, you are usually tracking the spot price of that commodity.

There are a few ways ETFs can invest to do this. They can invest in derivatives like futures – a product like Betashares Crude Oil Index ETF (ASX: OOO) is an example of this - or they can directly buy the commodity and store it.

If you invest in one of the gold ETFs in Australia, such as GOLD, NUGG or PMGOLD, they buy gold bullion and store it in a bank vault. A bitcoin ETF like IBTC, EBTC, VBTC or BTXX purchases bitcoin and store it with a crypto-custodian like Coinbase or Gemini. For some of these types of products, you can even redeem your unit holding for the physical asset.

Commodities are typically uncorrelated to equities, fixed income and cash – and metals like gold have traditionally been used as a hedge against inflation and store of value. But it’s worth remembering that assets like this don’t typically generate an income for you.

When it comes to cryptocurrencies, price movements have been quite volatile in the past few years so that is something to weigh up while factoring its tremendous growth.

For those looking at income, that’s where alternatives such as private equity, private debt, real estate, natural resources and infrastructure might come in.

Often as not, you’ll find these types of assets in a Listed Investment Vehicle – or for real estate, a Real Estate Investment Trust or REIT. It’s not really surprising that these types of investments are more likely to be found in a close-ended structure like a Listed Investment Vehicle because you can’t just create more units of a particular commercial building to accommodate investor demand – although you might do a capital raising to purchase an additional building for the fund.

These types of listed investments are usually actively managed by a specialist fund manager, and some of them will even offer set contracted rental yield paid to investors.

For example, Tribeca manages a global natural resources fund, listed as TGF, Pengana runs a private equity fund, listed as PE1, or Metrics manages two private credit listed funds, MOT and MXT. There are also listed options that invest across a mix of these alternative assets such as WMA offered by Wilson Asset Management.

You’ll often find you are investing alongside institutional investors in these sorts of products too, which you might find comforting given the extensive research that happens in institutions before they invest money.

Now, there’s one last category of alternative investments I’ll cover off, and that’s hedge funds. These might hold traditional assets like equities but take unusual strategies, like absolute return, gearing or shorting, to perform differently.

When it comes to hedge funds, you’ll find both ETF and LIV options, and this comes down to fund manager preference.

For example, fund managers like Platinum offer two LIVs in this space PMC and PAI but also offer three active ETFs: PAXX, PGTX and PIXX. L1 offers a long-short portfolio as a LIV under LSF and two active managed ETFs: L1HI and L1IF. You’ll also find well-known ETF issuers like Betashares, Global X and VanEck have products in this space.

There are a lot of different strategies that fall under the hedge fund category so you’ll need to do your research on which type of strategy suits your portfolio first before looking into the products available.