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The Low Correlation Strategy - an alternative way to hedge your share market risk

May 2016

MLC’s multi-asset portfolios – using alternatives to hedge your share market risk

With market volatility sweeping global share markets, it’s worthwhile looking at the role alternatives play in MLC’s multi-asset portfolios and the benefits they may bring you.

Our multi-asset portfolios are extensively diversified

Investment markets, and the returns they deliver, can be unpredictable and volatile. So you may feel uncertain about simply relying on market performance to deliver the returns you need. This is why we have multi-asset portfolios that are extensively diversified across a wide range of assets, strategies and investment managers to enhance returns and manage risk.

Using alternatives to smooth returns and manage risk

Different types of assets perform well in different times and circumstances – when some are providing strong returns others may not be. And in some market environments, simply investing in mainstream assets (like shares, fixed income and cash) won’t always provide the returns you need to achieve your investment objectives.

Our multi-asset portfolios include investments in carefully chosen alternative assets and strategies that aim to produce returns that are different from other asset classes, particularly share markets. Including alternatives helps us smooth the portfolios’ returns and reduce reliance on share markets to deliver on their objectives.

‘Alternatives’ is a very broad label that masks many different strategies – with varying levels of liquidity, risk and diversification to shares. The Low Correlation Strategy (LCS), managed by MLC’s Alternative Strategies team, seeks to identify alternative strategies that are high quality and meet the needs of our multi-asset portfolios.

The purpose of LCS is to increase the diversity of sources of return and risk in our MLC Horizon and Inflation Plus portfolios. By combining several carefully selected specialist managers and strategies, mostly hedge funds, LCS aims to provide a pattern of returns that is both positive and mostly independent of, or ‘uncorrelated’, with each other and share markets. We expect this will help to smooth out the pattern of returns in these portfolios.

The underlying strategies in the LCS are ‘alternative’ strategies. This means their managers:

  • adopt strategies that are different to the traditional asset classes of shares, fixed income and property, and
  • take an ‘absolute return’ approach to investing: instead of trying to beat a market benchmark, they aim to deliver consistent positive returns regardless of what markets deliver.

Effectively, LCS is designed to deliver returns, even when shares are doing poorly or drifting sideways. While the strategy doesn’t have the big upward movements of share markets, it aims to avoid those big downward movements, thereby helping to smooth these portfolios’ returns.

LCS has been part of the MLC Horizon and MLC Inflation Plus portfolios since 2012 and the Alternative Strategies team has successfully managed this strategy for some of MLC’s large institutional clients since 2008.

MLC’s Alternative Strategies team

The MLC Alternative Strategies team has three experienced investment professionals, who have worked with MLC for many years. They are very familiar with MLC’s approach to portfolio construction and the investment objectives of the MLC Horizon and Inflation Plus portfolios.

The team works closely with MLC’s Capital Markets Research team, which manages those portfolios, to provide a stream of returns that is complementary to the other strategies the portfolios invest in.

LCS is diversified across several hedge fund managers and strategies

LCS currently has 11 managers running different strategies, each chosen because their returns are largely unconnected both with one another and share market performance.

When choosing the hedge funds, there are two main drivers of return we are generally looking for:

1. Exposure to unique risk premiums

Some hedge funds pay a return to investors for taking on a specific type of risk that isn’t correlated with the usual investment risks such as share market and interest rate risks. These hedge funds can be unusual and hard to find. An example of one is insurance related investments. These are investments in natural catastrophe risks. Investors take on the role of an insurer. They receive a yield - effectively an insurance premium - for taking the risk of a particular natural catastrophe causing losses above a certain level. Insured events are typically for relatively low probability events, such as major hurricanes and earthquakes.

As the occurrence of natural catastrophes has no expected correlation with share market movements, the strategy is an attractive source of diversification. For example, during the global financial crisis, shares fell but insurance related investments performed well.

2. Active management, generally via hedge funds

There are lots of reasons to be sceptical of hedge funds – the fees are often too high relative to their expected value and they can be very complex. That said, if you have the ability to do deep research on these funds, it’s possible to uncover some extremely high-quality firms, and one of the key reasons is that hedge funds have a structure that will attract the best investment talent. They’re attracted for two main reasons. One is simply that if you’re a skilled fund manager, hedge funds tend to pay the best. The second is that hedge funds provide the most flexible investment vehicle for that talent to manifest – for example, there’s no need to hug market benchmarks, and they can be opportunistic and focus on absolute returns.

Conclusion

Through investing in our MLC Horizon and Inflation Plus portfolios, you’re accessing carefully selected hedge fund managers and strategies that we hold in high regard and which are usually only available to large institutional investors. We believe this is where LCS provides our investors with an efficient and low risk means of accessing alternative strategies.

With the continued volatility of investment markets, it can be a difficult time for you to feel confident about your investments and financial future. Knowing that our portfolios are extensively diversified and include strategies that aim to provide you with smooth returns, whatever the ups and downs of the market, may give you more confidence you’ll get the returns you need to help achieve your financial goals.

Important information

This information is provided by MLC Investments Limited (ABN 30 002 641 661 AFSL 230705), a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) group of companies, 105–153 Miller Street, North Sydney 2060.

This communication contains general information and may constitute general advice. Any advice in this communication has been prepared without taking account of individual objectives, financial situation or needs. It should not be relied upon as a substitute for financial or other specialist advice.

Before making any decisions on the basis of this communication, you should consider the appropriateness of its content having regard to your particular investment objectives, financial situation and individual needs.  You should obtain a Product Disclosure Statement or other disclosure document relating to any financial product issued by MLC Investments Limited and consider it before making any decision about whether to acquire or continue to hold the product. A copy of the Product Disclosure Statement or other disclosure document is available upon request by phoning the MLC call centre on 132 652 or on our website at mlc.com.au.

An investment in any product offered by MLC Investments Limited does not represent a deposit with or a liability of National Australia Bank Limited or any other member company of the National Australia Bank group and is subject to investment risk including possible delays in repayment and loss of income and capital invested. None of National Australia Bank Limited, MLC Investments Limited or any other member company in the National Australia Bank group guarantees the capital value, payment of income or performance of any financial product referred to in this communication.

Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. Actual returns may vary from any target returns described in this communication and there is a risk that the investment may achieve lower than expected returns.

The investment managers are current as at the date this communication was prepared.  Investment managers are regularly reviewed and may be appointed or removed at any time without prior notice to you.

This information is directed to and prepared for Australian residents only.

While MLC Investments Limited has taken all reasonable care in producing this communication, subsequent changes in circumstances may occur and impact on its accuracy.