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Skewing the investing odds in your favour

- An alternative approach to alternatives

November 2016

By MLC

With the prevailing view that prospective returns from today’s starting valuations for bonds and equities are likely to be low for sometime, now more than ever before, investors should be looking at alternative strategies that generate returns from sources different to traditional asset classes.

Within liquid alternatives or hedge funds, we believe investors should use some combination of the following three approaches to improve their likelihood of achieving investment success:

  • follow the path less well-trodden;
  • embrace the rise of the machines; and
  • emphasise direct access to strategies.
Follow the path less well-trodden

Close to half of the US$3 trillion in aggregate hedge fund industry assets are allocated to just two strategy categories: long/short equity and event-driven strategies. In our experience an approach which avoids these well-trafficked strategies in favour of smaller, niche strategies is likely to prove more rewarding. One such example is mortgage prepayment risk, which provides a return to investors for taking on the risk that US mortgagees prepay their mortgages faster than expected. Given the inherent complexity and potential illiquidity of these securities there are few natural owners of prepayment risk, creating a structural return driver that is complementary to traditional asset classes. Despite manager fees, which are high, primarily reflecting the specialist skills needed in analytics and risk management, our experience in this space has been very positive.1

Embrace the rise of the machines

According to IBM 2.5 quintillion bytes of data is created each day, so much data that 90% of the world’s data has been created in the last two years.2 Given ongoing advances in computing power this trend is only set to intensify. Two years ago we shifted a meaningful portion of our alternatives portfolio to a group of systematic managers with the skill-set, IT infrastructure and experience capable of exploiting this trend. Collectively these managers have produced strong net of fee returns.1

Emphasise direct access to strategies

Lastly, we think investors should structure their portfolios as efficiently as possible. This means only paying incremental investment fees where they’re warranted, and where available accessing strategies directly through lower fee, scalable investment solutions. Over the last two years we have partnered with managers to implement bespoke investment solutions in natural catastrophe reinsurance, and more recently within the alternative beta/risk premia space, both at significant savings to typical hedge fund fees.

While we still firmly believe higher fees are warranted on a selected basis (such as in prepayment risk and systematic strategies), a combination of both carefully selected hedge funds and direct access strategies makes sense for most investors.

Our Low Correlation Strategy which includes exposure to these strategies is invested in by MLC’s multi-asset portfolios. This strategy has achieved a return of 6.9% pa since inception of the strategy in 2008, essentially matching the performance of equities over this period with significantly lower volatility, in part due to the use of these approaches.1,3 While their use is no guarantee of investment success, we believe they help to skew the odds of investment success in our investors’ favour.

For more information,visit mlc.com.au

1. 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. 

2. ‘Bringing big data to the enterprise’, IBM, 14 November 2016. 

3. For the period ending 30 September 2016. Returns are reported gross of MLC fees but after deducting underlying manager fees.

 

Important Information

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