Caution urged on alternatives allocations

Superannuation funds have been cautioned against expecting too much from alternative investment allocations, particularly when infrastructure and private equity are stripped from the equation.

A new analysis, undertaken by Frontier Advisors, of Australia's largest superannuation funds has raised questions about the effectiveness of some types of alternatives in diversifying portfolios and enhancing returns in challenging markets.

The analysis comes as super funds have approximately doubled their exposure to alternative assets between 2007 and 2016.

Frontier Advisors senior consultant, Greg Barr, said: "We've recently seen super funds go down the road of increased allocations to the broad category of ‘alternatives' — and why?".

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"It's quite simple: we're looking for diversification in portfolios, a return enhancer and we're looking for better management of downside risk. So the ‘alternatives' exposure has become a ‘magic pudding' which is expected to deliver growth-like returns, lower risk, and low or negative correlations to equities."

Barr noted that, based on aggregate industry data, funds with higher alternative asset allocations posted marginally improved crediting rates over the financial year to date as traditional markets have struggled.

But he cautioned that the result was reversed — higher alternative allocations actually dragged down crediting rates — when infrastructure and private equity were stripped out of the alternatives universe.

"The other assets within alternatives in terms of hedge funds, absolute return funds and the very well named ‘miscellaneous alternatives' and ‘alternatives other', haven't actually delivered on that premise of low to negative correlation to equities," he said.

"The ‘magic pudding' of having higher returns, lower risk, and low correlation to equity markets is indeed hard to find and hard to achieve in these categories," Barr said.

He said Frontier looked at alternatives in a different way.

"We divide up alternatives to make sure you're looking at the actual characteristics of the strategy you're investing in, for example those that are return-seeking, those that are diversifiers, and those that are opportunistic investments," Barr said.