Macquarie Fund Manager challenges alternative asset allocation approach

18 February 2004

Macquarie Funds Management Head of Asset Allocation, Robert Credaro, today challenged the accepted finance industry approach of allocating only a five per cent of an investment portfolio to alternative assets.

Speaking at an Asset Allocation Forum in Sydney, Mr Credaro said that investors with a spread of alternative assets, including private equity, infrastructure, commodities and hedge funds in their portfolio can actually allocate considerably more to alternative assets without raising expected portfolio risk. This approach can even build a level of defensiveness into an investment portfolio.

Mr Credaro said the challenge in this strategy is to move the accepted thinking away from asset allocation to risk allocation.

“A five per cent allocation has been accepted as the standard on the basis that investors are considering only looking at one type of alternative like private equity, and on its own it can be quite risky. Once you introduce more than one alternative into a portfolio, you can start making a larger allocation to these usually higher return assets,” Mr Credaro said.

“The key difference between alternatives and mainstream investments is that mainstream assets have a high proportion of expected returns coming from systematic factors like broad economic cycles, interest rates and inflation while alternative assets have a greater proportion of expected returns from non-systematic factors like manager skill.”

“There is no need to overstate the case for alternatives – they have a role and possibly a greater role than previously considered, but not as an exposure to a single alternative asset.

“Macquarie Funds Management research shows that investors who include a mix of four or five alternative assets, comprising up to 20 per cent of their portfolio, can potentially benefit from improved upside while reducing the volatility of their alternative asset allocation.

“The fact is that if you increase the alternative asset allocation to up to 20 per cent of a portfolio and diversify across four or five carefully selected alternative asset classes, you can get diversification and volatility close to that available from listed equities.

Mr Credaro said this diversification strategy should only extend to four or five alternative assets, as any more will make the exposure unnecessarily complex without extra return or risk advantage.

“The four alternative assets classes that we have found work well together are private equity, infrastructure, hedge funds and commodities because they provide a spread of volatility and defensiveness in varying market conditions,” Mr Credaro said.

“It is very important that an investment in these alternative assets has an underlying strategy.

“With private equity, the maximum exposure and maximum diversification can best be achieved through a fund of funds. This diversification can provide reduced risk and ensures the underlying wholesale fund managers are selected on the basis of performance, style and risk assessment.

“Infrastructure as a general investment can provide some income, but investors should not underestimate the potential of investing in infrastructure projects while they are in the development phase with a global focus, as these have a much wider potential for growth.

“There are often sourcing difficulties with infrastructure investments. Infrastructure investments can be infrequent and the number of infrastructure managed funds available are very few.

“A broad diversification of commodities is also recommended as commodities do well when listed equities do poorly. This is a good way to build defensive assets within an investment portfolio and protect your portfolio against inflation.

“When including hedge funds, manager risk can be reduced by selecting one or two strategies (such as long-short equities and macro trading) and select a number of mangers who follow that strategy. If you diversify across too many hedge funds you simply end up with a balanced fund.”

Mr Credaro said increasing a portfolio’s exposure to alternative assets from five percent to 20 per cent was all about ensuring the strategy in each alternative asset class was correct and having the appropriate level of exposure to the four key alternative assets.

For further information please contact:

Irene O'Brien
Public Relations
Macquarie Financial Services Group
Macquarie Funds Management Group
Tel: (612) 8232 3241
Mobile: (61) 417 260 309

This information has been produced by Macquarie Funds Management and is current as at 18 February 2004. The information may be based on assumptions or market conditions and may change. This amounts to general advice only, and has been prepared without taking into account any investor’s objectives, financial situation or needs, which should be considered, together with the relevant offer document (if any), before investing.