It’s no secret a diversified portfolio may help to protect your wealth from market ups and downs.
Including investment alternatives in your self-managed super fund (SMSF) may therefore provide additional diversification.
But what exactly are alternatives and what can they do for your portfolio? We take a closer look under the hood to find out more.
How alternatives could fit within your self-managed super fund
Alternatives cover a very wide range of asset classes that could be incorporated within your self-managed super fund, should you choose to. Their performance, as well as associated risks, can differ greatly.
As the name suggests, alternative investments fall outside of the traditional asset class sectors of shares, listed property, fixed income and cash. Broadly, the different types of alternative investments include:
- Commodities – which cover a wide range of assets such as live cattle, wheat, corn, soybeans, gold bullion, copper, aluminium, oil and coffee;
- Infrastructure – covers services essential for communities such as airports, roads, power, hospitals and telecommunications;
- Private equity – investments in unlisted companies that offer the prospect for increases in shareholder value. Also known as “venture capital”, which is an early stage private equity investment;
- Hedge funds – which aim to protect investment portfolios from market uncertainty, while providing positive returns during both upward and downward trends in the market;
- Real assets – Direct property such as retail or commercial premises or facilities;
- Other direct investments, such as artwork and antiques.
The benefits of alternatives in a self-managed super fund
The main attraction of alternatives is that they tend to be less correlated to the major asset classes of equities, bonds, property and cash.
Correlation refers to the relationship between the returns of two different investments. For example, if two different assets move in the same direction at the same time, they are considered to be highly correlated. On the other hand, if one asset tends to move up when another moves down, the two assets are considered to be uncorrelated.
So in periods when traditional markets trend downwards, allocations to alternatives may not move in the same direction, or may even move in the opposite direction which can potentially provide an extra layer of diversification for your self-managed super fund.
Importance of diversification in a self-managed super fund
The importance of diversification for self-managed super investors was highlighted in research conducted by Investment Trends and the Self-Managed Super Fund Association, where just one in five advisers considered their self-managed super fund client portfolios to be well diversified.
In addition, 64 per cent of self-managed super fund advisers acknowledged even a portfolio of 30 individual stocks many not provide sufficient diversification – particularly when combined with a strong bias of investing domestically.
And the drawbacks
While alternatives can be an attractive diversification method, they also carry some risks. In addition, as they’re often not traded on an open market such as the ASX, it may be more difficult for investors to sell these investments and cash out. But just like any investment, the potential for a higher return or complexity of the investment strategy generally carries a higher level of risk.
Getting access to alternatives for your self-managed super fund
While alternatives have been historically used by institutional investors such as super funds, pension funds and government sovereign funds (e.g. our own government’s Future Fund) their higher initial investment served as a barrier for many self-managed super fund investors. For example, investing in an infrastructure project such as a new airport could cost hundreds of thousands, or even millions of dollars.
But gaining exposure to different markets and asset classes, including alternatives within your self-managed super fund has now become easier. Thanks to managed investments and exchange-traded funds, you can gain diversification across asset classes, locally and globally.
Alternatives may be a useful diversification tool in a broader self-managed super fund due to their lower correlation to traditional sectors. But like all investments, they’re not risk free so you may find it worthwhile to speak to your financial adviser about your current portfolio to determine if investing in alternatives is suitable for you.