Depending on your age, you may think of "alternatives" as a counterculture like hippies, punks, indies or hipsters. However, rather than finding them on a Melbourne street sporting a penny farthing and lederhosen, it may surprise you to know they’re in your super fund.
"Alternatives" are a very diverse class of assets; pretty simply, they’re everything that doesn't fit into the category of Shares, Property (Real Estate), Cash or Fixed Income. This can be commodities like oil, wool, gold, or other assets like currencies, financial derivatives and hedge funds.
Australia’s Future Fund has around 15% invested in alternatives and many super funds can have around 10% in their portfolios. Generally, like some countercultures, they’re fabulously interesting to encounter in small doses but over-exposure can lead to a wild ride!
The main reason they appear in a portfolio is diversity, which allows investors to spread market risk. Some alternatives will zig when other financial markets zag, and sometimes (like hippies) they’ll just dance to the beat of their own drum oblivious to the outside world.
You are probably aware that the investment markets in the past few months have been tough; this is due to a range of reasons including the Central banks of the world looking to reduce the cheap money that they’ve been flooding the world with since the GFC 10 years ago. Alternatives generally have also suffered significant losses recently which is contrary to what we’ve come to expect. Traditionally, when growth markets hit the skids, investors divert their investment funds to fixed income or alternative safe havens such as gold or a commodity (tangible assets) that can be sold later. That demand can drive prices for those alternatives up.
This time around however (since the end of August 2018), it’s been a bumpy ride partially due to the repricing down of assets. If the world doesn’t have as much cash to splash (due to Central banks), there is less demand for assets be it shares, property, alternatives etc etc. That tightening of cash also increases interest rates which in turn leads to a lower rate of future investment return (refer to a discounted cash flow*) so again, asset prices drop. However, alternative investments can be volatile both down and up so don’t write them off just yet. They are in our collective super funds for a reason and I expect that alternatives will begin to look attractive when the price is low enough. After all, investors love a bargain…
Give me a call if you want to have a chat about alternatives; it’s a topic I love to talk about (investments, not hippies)!
*Keep an eye out for my next blog on discounted cash flows and why they matter!!