Do your clients dream of owning their own macadamia plantation in Queensland? How about funding a desalination plant in China? Or hedging their bets on Aboriginal art? A dazzling array of weird and wonderful investment opportunities is scaling new heights of popularity. As alternative investing catches on, savvy fund managers are pushing everything from artwork to almond trees onto retail investors, who are jumping into products with relish in the hunt for alpha. Australians have 15 per cent more invested in managed funds than the second placed nation, the United States, so it is no surprise to see the boom of alternative assets - hedge funds and private equity - and the renaissance of emerging markets.
The number of retail investors allocating funds into alternative classes either directly or through a financial planner has doubled in the past five years, according to an upcoming Macquarie Bank/Investment Trends alternative investments investor report. "Advisers are opening their eyes to other possibilities," Investment Trends principal Mark Johnston says. "It's not about a particular kind of asset - [investors] are continuing to use a wide range of alternative investments. "There has been a plethora of new products launched to meet the demand." Alternative assets may only represent around 5 per cent of total managed funds in Australia, but this is expected to increase to 9.1 per cent in 2008. Total alternative assets under management now exceeds $45 billion. Nine per cent compulsory super has buoyed this growth, while a property slowdown has seen investors look to other options.
It's not only the institutions. Retail investors are no longer dismissing alternatives as too risky, but are seeking out multi-asset strategies to ward off volatility, venturing from the typical mix of shares, property, bonds and cash. Macquarie/Investment Trends surveyed 3000 retail investors and the report reveals that asset allocation of alternatives is between 22 per cent and 27 per cent. "I was surprised that the asset allocation was as high as it was. [And] there's still room for growth," Johnston says.
Opening the floodgates
Fund managers are capitalising on the long-running bull market by offering high-yield products previously only open to the institutional market. Hedge funds are a classic example. Ixis, the Australian distributor of US-based fund of hedge fund manager Harris Alternatives and Dexion Capital, is making hedge funds more accessible to domestic investors through daily pricing and greater liquidity. Investors can now trade on the London Stock Exchange through Dexion Absolute, a fund of hedge fund that was introduced to Australia late last year. As proof of local demand, Dexion is planning another Australian capital raising project in September. In February, investment manager Legg Mason went alternative and introduced a US fund of fund product to the market. But are investors keeping up with the myriad possibilities on offer? "There's a growing awareness of the need to diversify personal investment portfolios," AFG Financial Planning dealer principal Ross Nayler says.
Australian investors have become a lot more sophisticated and want total returns, with private equity and direct property popular avenues in which to diversify, Ixis Asset Management Australia managing director Karyn West says. "The better the markets go, the more likely the name of the game is diversification on a broader scale," West says. Select Asset Management portfolio manager Robert Graham-Smith says: "We believe that people who invest in mainstream investments only are running a diversification risk. "Returns from alternative investments tend to have a lower correlation and dependence on traditional share and bond markets."
Self-managed super fund trustees in particular are now seeing the benefit of alternative assets, Macquarie Bank head of retail agribusiness Anthony Abraham says. "The Government's changes of 30 June are really focusing people's minds," Abraham says. An alternative by any other name
It's the old chestnut - just what is an alternative investment? Understanding the different definitions is crucial for advisers in coming to grips with a complicated playing field that holds traps for the unsuspecting investor. "I don't think alternative investments are a particularly useful sort of heading," Morningstar head of research Anthony Serhan says. Serhan says alternatives are largely characterised by anything that is not listed and by nature are not highly correlated with traditional equities market. "From a diversification point of view they have some definite appeal," he says. "When you look at some of these assets, the fact that they're not very liquid means that they will produce higher returns." The institutional market takes a broad view of what is alternative. Products are classified by strategy, such as hedge funds; structure, such as the use of derivatives, short-selling or capital protection; or alternative by asset class, that is, any investment that is not a listed equity, fixed income or property, typically infrastructure, private equity, commodities and agribusiness.
A convenient truth
The environment - in particular a growing awareness of climate change - is also changing the way investors view their portfolio. Alternative energy is one area that is gaining momentum. In 2005, the best performing stock on the Australian Stock Exchange (ASX) was uranium producer Paladin, which increased by 720 per cent. Babcock and Brown Wind Partners Group, which has 31 wind farms on three continents, is forecast to be among companies that pay the biggest dividends in 2007. Macquarie Bank, which began a portfolio of forestry and agribusiness schemes four years ago, is soon to launch a fund giving retail investors exposure to carbon trading through mallee tree plantations. The trees will be planted to offset greenhouse gas emissions on cleared farmland in Western New South Wales, and could be the start of a multi-million dollar industry in international emissions trading.
Private equity
The emergence of private equity assets open to Australian retail and institutional investors has never been higher, fuelling the growth of alternatives. The numbers of deals has risen, as has the size of deals. However, liquidity concerns continue to keep retail investors away from private equity, as do structures that generally do not cater for them, Macquarie Funds Management alternative investments division director Robert Credaro says. "The way most people get access to private equity is through their super fund," Credaro says. "Because it's been so hard to get access to private equity, it's been talked about more than it's been done." It's a different story for institutions. Announcing its fifth private equity capital raising earlier this month, ING Investment Management director of private equity Jon Schahinger said opportunities in the private equity sector continued to grow as specialist managers matured and investors showed a growing acceptance of the asset class. "We predict continued strong deal flow through quality local managers however, as ever, access to the best fund managers will continue to be tight," Schahinger said.
He said concerns around the public interest and debt levels would remain largely a function of so-called mega deals such as Qantas and Coles, which had recently heightened investor awareness of the risks as well as benefits of private equity. "There have been some alarmist claims aired in the press but experienced private equity investors manage their risk by constructing diversified portfolios," he said.
Agribusiness
Agribusiness has been around since time immemorial, but the sector has been fuelled by lucrative tax benefits for investors. Until now. The Federal Government plans to axe tax relief on managed investment schemes (MIS) for non-forestry agribusiness investments, a decision that has infuriated the agribusiness industry. Australia's first macadamia nut MIS is one that is seeking to capitalise on tax relief before the proposed cut off of June 30, 2008. Maccacorp managing director Don Ross says the scheme is targeting boutique financial planners and can provide a regular income flow for retail investors, who can buy one acre allotments of a Bundaberg macadamia orchard. Investors need to be patient - harvesting will not start for another four years and the investment term is 21 years. "The macadamia industry is a small but growing industry. We believe that we have the expertise to make it grow," Ross says. Super's going alternative
Almost one-third of Australian super funds now invest in alternative investments, according to a recent report by the Reserve Bank of Australia. It found that internationally, alternative strategies have outperformed traditional global equities with a lower level of total volatility. The Motor Trades Association of Australia Super Fund (MTAA) has a huge 43 per cent of its assets in alternatives. "The MTAA's decision to invest in alternatives was prompted, in large part, by the knowledge that the privatisation of state-owned assets would release a lot of value once they had to operate under market conditions," former trustee of the fund John Rickus says. Indeed, the legacy of government-owned infrastructure has kept investors from infrastructure because of the stigma of bad returns. However, assets like toll roads, water utilities and airports (think Macquarie Bank) are increasingly open to investors and can provide solid returns because they are essential services.
Master trusts are also increasing their allocation to alternative assets as they aim to match the performance of their industry fund counterparts. Super funds are putting a lot of money into global infrastructure, such as toll roads and water companies, says Sovereign Investment Research director Ray King. They are avoiding large private equity consortiums, such as Kohlberg Kravis Roberts (KKR), in favour of smaller funds. King says super funds believe the KKRs of the world are paying too high a price for politically-sensitive assets. He says while there are some reservations about hedge funds in general, there are some very good funds that will continue to perform well. Only a few years ago, super funds held between 5 per cent to 10 per cent of alternative assets in their portfolios, he says. Now, it's more like 15 per cent as funds don't think the increase will significantly upset the risk/return profile. "It's also being supply driven - there are a lot more products," King says.
Alternative by any other name
Capital protected structures are increasingly popular for risk averse investors. ING's platform, OneAnswer, launched a capital protected fund earlier this month, giving access to long-only US equities, long/short European equities and a multi-strategies hedge fund. The fund is tailored to meet the needs of advisers who are increasingly using or recommending alternative assets for their clients, ING head of personal investments product and strategy David Kan says. "Clients are becoming more sophisticated and there is demand for different tools and products to suit different age brackets and different needs," Kan says. Johnston agrees. "We think that capital guaranteed products will continue to be a growth area," he says.
Are they worth it?
Alternative funds are notorious for charging higher fees due to the complexity and difficulty involved in managing the assets. Managers defend the costs as being offset by absolute returns. A State Street report released this month shows institutions are currently more comfortable investing in hedge funds than 12 months ago but remain concerned about fees. High fees offsetting returns was identified as the greatest threat to hedge fund investing by nearly a third of institutions. King says the fees charged by alternative funds continue to worry investors. "You really have to do your homework that you'll be confident of 15 to 20 per cent returns, otherwise they'll be very expensive," he says. Alternatives are also criticised for their lack of transparency. In June, AMP removed 11 industry super funds from its approved list. It said one of the reasons for doing so was a lack of transparency among industry funds thanks to their high allocations to alternative assets. Some financial planners steer clear of alternative funds altogether, preferring to stick with a bread and butter diet of equities, bonds and cash. Melbourne-based Australian Private Capital licensee Michael Tratt does not deal with alternatives, saying he has a pure approach to investing his clients' funds.
Tratt uses asset manager Dimensional Fund Advisors (DFA Australia), which invests in equities, fixed interest and small cap stocks, and steers clear of strategies like hedge funds and private equity. A lot of people are taking on added risk and forgetting that risk and return are related, DFA Australia regional director Jim Parker says. "We tell advisers who work with us, 'you'd better make sure you're rewarded for your risk. Be aware you're properly diversified'," Parker says.
Count Financial is not unusual as a dealer group in being cautious about alternatives. Count limits the alternatives on offer to its advisers (typically, investors can have 10 per cent of their portfolios in hedge funds) and only has a handful on its approved product list. "We started off with fund of hedge funds and over the past couple of years this has expanded to multi-manager funds," Count research and product development senior executive Rachel Griffith says. "It doesn't make sense to put all your money into one of these kinds of things."
