To protect against the possibility of large losses in a market downturn, Australian investors should diversify into assets that are not overly affected by recession, according to Ibbotson head of alternative investments Michael Coop.
Examples of assets that would withstand a recession include insurance-linked securities, shares in utility companies, and global macro hedge funds and managed futures, Coop said. These types of assets are effective fundamental diversifiers, he added.
Insurance-linked securities (ILSs) have unique fundamental risks that differ from normal bonds. If the insured event (eg, a hurricane or an earthquake) occurs, an ILS may lose 100 per cent of its value. But a diversified pool of ILSs would return a steady income with a fundamental risk that is detached from a national recession, Coop said.
Government-regulated utilities are other assets that perform well during a recession, because the Government directly controls their return on capital, Coop said.
“The fundamental risk of regulated utilities is in fact adverse government regulation rather than economic recession,” he said.
When it comes to hedge fund strategies that take advantage of trends in a volatile market – such as managed futures and commodity trading advisors – the fundamental risk is poor manager selection, Coop said. However, there also needs to be a clear trend in the market to follow, so a relatively flat market can lead to poor returns, he added.
Capital preservation is particularly important because it can take many years of high returns to recover from market downturns, Coop said.
