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It's time to look at Alternatives

Daniel Tamone

The SILC Group

As we approach the halfway mark of 2021 it’s fair to say there’s a lot going on. The first 100 days of the Biden presidency have elapsed, the COVID-19 vaccine is rolling out around the globe, and a V-shaped recovery continues in equities amid record low-interest rates and excess cash in circulation thanks to worldwide QE programs. Given all this, we believe the increased flows into Alternatives is set to continue.

What are Alternatives?

“Alternative” in its simplest form means “one of two or more available possibilities.” A more appropriate definition when referring to investments is “relating to activities that depart from or challenge traditional norms” (In this case the “traditional norms” being stocks, bonds, and cash.)

Pictured below is a brief overview of some of the more common Alternative investment asset classes.

Alternatives can drive outperformance

The Future Fund is Australia’s sovereign wealth fund and was established with the goal of strengthening the Government’s long-term financial position. The role of the fund is to generate high, risk-adjusted returns over the long term. The Future Fund has been remarkably successful in executing its strategy thus far, with a 10-year annualised return of 9%. This was greater than that of AustralianSuper’s Balanced Fund, which was 8.77% over the same period.

The success of the Future Fund can be attributed to its unique portfolio of holdings, of which approximately 41% is invested collectively in Alternative assets.

Image below is the asset of allocation of The Future Fund as of 31/12/20, the assets classified as alternative holdings are circled.

There is a common misconception that Alternatives are an exclusive asset class. Historically this may have held true, but alternatives have become increasingly prominent globally and are available in various, easily accessible forms. Investors now have the luxury of not only investing in property and private markets as an alternative to stocks and bonds, but can dip their toe into a range of investments from prestige cars and collectibles to impact investments, all with impressive, and most importantly uncorrelated returns. 

The rapid growth seen in Alternative investments is not stopping any time soon. We expect the move to alternatives, as a method of investors diversifying their portfolio, to continue to grow in the foreseeable future, as demonstrated below.

Image: Alternative assets under management ($tn)

Source: Preqin.

There’s diversification, and then there’s non-correlation

Diversification is widely regarded as one of the most fundamental necessities of portfolio construction, and rightly so. However, when we look back over the dot com bubble, GFC and COVID-19, diversification hasn't saved investors only invested in traditional asset classes from pain.

To be truly diversified, one needs exposure to non-correlated assets and a portfolio that enables the deployment of capital at times of stress to take advantage of market dislocations.

Equities traditionally take up the lion’s share of most portfolios. This is justified by historical returns and liquidity (which evaporates when you need it the most). History shows that when equities fall, they can fall hard. This can be viewed as a risk to the complacent, and an opportunity to the tactical. It's in these sudden downturns that privately held, illiquid investments outperform.

The chair of the Future Fund, Peter Costello believes that minimising exposure to global macro factors is key to maintaining target returns. "The Future Fund is positioned to have less risk and less volatility than a balanced fund so that it can outperform in periods of downturn." This pledge was proven in Q1 2020, when the Future Fund recorded a negative return of 3.4%. Over the same quarter, the ASX 200 fell 23.1%, an outperformance of 19.7% for the Future Fund.

Image: The below chart by Goldman Sachs demonstrates how liquidity can dry up during market downturns:

Source: Goldman Sachs.

It’s no surprise that the illiquidity spikes are coordinated with spikes in volatility and market downturns.

Image: VIX and S&P500 

Source: Bloomberg and Cboe. 

With Warren Buffets favourite indicator (market value of the stock market to GDP) at all-time highs, only the wishful thinkers can seriously think that these valuations can be sustained in the long term.

Image: Buffett Indicator.

Where do you look?

Alternatives provide the ability for investors with varying interests to get involved and invested. They’re also far less likely to be affected by the volatility experienced by global equity markets.

Lex Pedersen, founder of e-commerce business, Surf Stitch is all too familiar with the volatility of listed markets and in a previous article by Livewire said, “It baffled me how uncorrelated influences could drive volatility in valuation and share price.”

“I discovered a passion for luxury and prestige cars, and I have been investing in them for over a decade. Over this period, not only have the gains outperformed the mainstream asset classes with yo-yo like volatility, but these cars have also been rock solid and steady.”

This passion is shared by many. According to Lex, this opportunity has been welcomed by car aficionados and investors looking to diversify their portfolio alike. This led to the establishment of the Chrome Temple Investments Mach I Fund, providing investors with the opportunity to enter this space.

The Hagerty Composite and HAGI produces indices to track the performance of the luxury car market.

In addition to the luxury car market, impact investing has emerged as a new alternative investment strategy. Amanda Goodman from Impact Investment Group, a leader in identifying investment opportunities that offer commercial returns while creating a positive social and environmental impact says, “Impact investing has really taken off over recent years and it’s something we have been building a track record in for almost a decade across green property, renewable infrastructure and impact venture capital. We believe that by identifying assets and companies that are addressing real world problems we are future-proofing our portfolio and helping drive outperformance. And because these investments are illiquid and typically have a much lower correlation to stocks and bonds, they have not experienced the same volatility as other traditional asset classes and provide a more valuable diversification strategy as a result.”

Another example of an Alternative with impact is Hope Housing. CEO Tim Buskens says, ‘It’s an unfortunate reality that essential workers, particularly in our capital cities, simply cannot afford to buy property on their modest salary. We have structured an investment that provides investors unique access to the Beta of the Capital Growth from Australian Residential Property Market, packaged together with a significant Impact Return, from the opportunity to co-invest in property alongside Australia’s unsung heroes.’

Brickfloor, a 2021 finalist for FinTech Australia’s Emerging Fintech of the Year, provides investors with an innovative way of obtaining diversified exposure to Australian residential property (established dwellings) with enhanced returns generated through offering home sale certainty via put options – and charging put option premiums. Home sellers can use this product to mitigate against property market downside price risk, to seek to leverage a higher sale price from the market, and as a mechanism to buy before they sell, safely. “Residential property is Australia’s largest asset class, is typically well understood by investors and can provide strong returns with lower volatility than many other asset classes, including listed equities and REITs. This is particularly the case where capital growth and rental yield can be complemented by other sources of income, in our case, put option premiums” said Dean Fraser, Founder & CEO of Brickfloor.

These Alternatives are examples of how you can lower your risk and ensure your return. We call this the zig, zag and zog model.

Putting Alternatives into practice

Craig Ferguson from Antipodean Capital says, “Historically, overvaluations in equities have been transitory and given the current state of the bond market, I am using Alternatives to provide capital protection as well as growth. Alternatives also enable us to position portfolios in a manner that will provide the ability to make dynamic and tactical decisions when the transition occurs.”

Moving forward

Those who rode out the V-Shaped recovery in various asset classes are breathing a sigh of relief, while those that jumped ship are licking their wounds.

Regardless, valuable lessons were learned in 2020, and investors should be assessing their portfolios and considering how alternatives can be better utilised.

Adam Morse, Managing Director of BlueRock Private Wealth, believes now is the time to look towards Alternatives, when structuring a portfolio. “Alternatives offer our portfolios uncorrelated returns, downside protection and ‘real asset’ style returns. We look for best of breed alternatives, across the style spectrum, with either a defensive or growth characteristics, as a genuine replacement for traditional asset classes.”

At The SILC Group we are excited by the growing investor appetite for exposure in Alternatives and are working with our investors and fund managers in implementing them into their portfolios and investment strategies.

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This document is prepared for use by wholesale clients only. It is a summary and marketing material only and does not constitute an offer of any kind. This material may not be reproduced, distributed or transmitted to any other person or incorporated in any way. The information contained in this document is general information only. This document does not (and is not intended to) contain any recommendations, statements of opinion or advice. In any event, the information in this document does not consider any individual person’s objectives, financial situation or particular needs. Past performance and/or forward-looking statements are not a reliable indicator of future performance. Prospective investors should seek professional advice prior to making any decision regarding an investment.

Daniel Tamone
Associate Director, Investor Solutions
The SILC Group

Daniel is a member of the Investment Solutions team at The SILC Group, which offers bespoke investment opportunities, capital raising and trustee services, administration and licensing services for wholesale fund managers.

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