Thursday, 11 August 2016

Many of us in the Investment team at QSuper present at our member seminars. A topic that gets a lot of questions from members in the audience is the Alternatives asset class. Most commonly people want to know why it’s called ‘Alternatives’, what kinds of investments make up QSuper’s investments in Alternatives and what has performance been like?

So in this post, my aim is to give a bit of a run down on Alternatives. 

In the industry the term Alternatives has many different definitions. At QSuper we use a very broad definition, classifying Alternatives as simply any investment strategy with very different return and risk characteristics from equities and government bonds. Equities and bonds are the two dominant asset classes in QSuper’s portfolio1.

Common examples of Alternatives across the industry include commodities, farmland and even managers that invest in equites and bonds but with an atypical investment style thereby offering some diversification benefits to a broader portfolio.

As many types of investments meet this definition of being different from bonds and equities we’ve established our own criteria to select Alternative investments. In meeting the investment objectives of our multi-asset class options1 we see most benefit will come from Alternatives that:

  • perform well when equities have negative returns since equities are the main source of risk in our portfolios.
  • have low exposure to long-term interest rates since most of QSuper’s investments (e.g. Fixed Interest, Shares, Property and Infrastructure) can all be impacted by movements in long-term interest rates.
  • are likely to deliver returns in excess of our these investment options’ objectives over the long-run.

In practice many Alternative investments can be in niche areas. This means that as a large super fund, we have to consider things like capacity constraints. That is whether the amount of funds that could be invested into some Alternative strategies is large enough to influence our portfolios and ultimately have the intended effect.

The main strategies within QSuper’s Alternatives portfolio today are:

  • Risk parity strategies - these strategies aim to diversify a portfolio across different asset classes (e.g. equities, bonds and commodities) based on the source of risk as opposed to by asset allocation. Risk parity strategies are much less dependent on rising share markets to deliver high returns than the traditional approach to diversification taken by most super funds.
  • Trend-following strategies - these strategies also invest in asset classes of equites, bonds and commodities. As the name suggests they favour investments that have delivered strong returns in the recent past. If equities have been rising these strategies will increase their exposure to equities. In contrast, if QSuper were considering its own allocation to equities recent strong returns could be a sign equities have become expensive and should be sold. Many trend-followers actually delivered strong positive returns throughout the GFC because they had effectively sold the returns on equities to others in the early stages of the crisis by taking a negative exposure.

Astute readers of our publications will have noticed some changes to our asset classes took place on 1 July. Specifically, Commodities has become a stand-alone asset class rather than being classified as part of Alternatives. These are investments in commodity futures giving direct exposure to movements in the price of say oil, copper or sugar prices. Historically Commodities have delivered strong returns in periods of unexpectedly high inflation whereas returns to equities and bonds have been quite low. Private Equity has also been reallocated from the Alternatives asset class to be part of the broader equities portfolio to better reflect the risks of these investments. A case study of a private equity investment can be found here.

Cumulative returns by asset class 2010_2016

Our allocation to Alternatives has increased over the past five years or so in the Balanced option and new strategies have been introduced including the risk parity and trend-following strategies discussed above. To date cumulative returns are on par with Fixed Interest and Equities. The chart above shows the performance of the Alternatives portfolio since 2010. Importantly, the Alternatives portfolio has been relatively immune from the ups and downs in the Equities and Fixed Interest portfolios, which is exactly what we want it to do. 

1. The term ‘QSuper portfolio’ or ‘our portfolio’ is used to refer collectively to the underlying portfolios of assets which in combination make up the individual asset allocations of the QSuper Lifetime and the Balanced, Moderate and Aggressive investment options.

2. From April 2010 to June 2015 this graph refers to the Diversified Alternatives portfolio and includes commodities and private equity. From 1 July 2016 QSuper changed the way it classifies asset classes and since this time the Alternatives asset class no longer include commodities and private equity.  Commodities is now a stand-alone asset class and private equity has been reallocated from the Alternatives asset class to be part of the broader equities portfolio. 

The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information.

Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.

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