The most effective ways to get into ‘alternative’ investment strategies, in the Australian context

In recent years, the palette of investment opportunities for the Australian retail investor has become very crowded. Areas that until recently were the province of professional investors – such as ‘alternative assets” (so named because they give exposures that are not correlated to the traditional share, bond and property markets), absolute-return funds (funds that invest for maximum return, without reference to any benchmark index, and which are typically long-short funds) and commodities – have become far more accessible to retail investors than ever before.

International exposures are common, ranging from broad international funds to specialist Asian and BRIC (Brazil, Russia, India and China) funds; and the cheapness and simplicity of exchange-traded funds (ETFs), which give a whole market or sector in one stock, has made wider diversification more easily accessible than ever before.

Much of the newer areas of the palette are a trader’s delight, but it also suits a long-term investment portfolio – such as a self-managed super fund (SMSF) – down to the ground.

Mark Holzworth, director of IndexInvest, a specialist portfolio adviser on index-based investments, says the ETFs in particular have opened up a much wider array of exposures to Australian investors.

“Investment has become very thematic, at any time there are a number of very big drivers in the investment world, and ETFs offer a cheap and simple way to play these themes. ETFs give investors simple and effective underlying exposure to a variety of markets and sectors, in both their domestic and international equities allocation: with just a couple of trades, they can put in place a well-diversified portfolio very simply.”

One of the biggest themes in 2011, says Holzworth, has been the rise in precious metals, in reaction to rising inflation, the European sovereign debt crisis and the USA’s parlous fiscal situation. “Gold in particular has been a very good performer, and we’ve been using the exchange-traded commodities (ETCs) to lock in this exposure.”

The ASX has six ETCs that enable retail investors to buy precious metals in its own right. The Gold Bullion Securities (ASX code: GOLD) give the investor ownership of one-tenth of an ounce of gold bullion, held in the London vaults of custodian bank HSBC Bank USA. GOLD securities may be sold at any time on the ASX, or (subject to certain conditions and fees applying) holders may redeem them at any time for cash or in exchange for gold bars. The price of a GOLD security is one-tenth of the A$ gold price.

Similar to the GOLDs is the Perth Mint Gold Quoted Product, or PMG (ASX code: PMGOLD), which is a security (technically a warrant) that gives you the right to own one-hundredth of an ounce of gold. The gold is held in Perth as bar or coin, and guaranteed by the Western Australian government.

Both products enable investors to trade in gold as if the investors owned physical bullion. This type of investing is a very clean and efficient way of ‘playing’ the gold price: instead of buying the corporate risk attached to a gold miner, an investor buying either GOLDs or PMGs is only ‘buying’ the gold price. There are no company-specific factors like mine life, resource security or hedging activity to complicate matters. The stocks simply track the A$ gold price very closely, and may be sold at any time on the ASX. There is normal brokerage on the purchase or sale, and the management expense ratio (MER) of the investment is 40 basis points (0.40 per cent) a year.

ETF Securities, issuer of the GOLDs, has also launched ETCs over physical silver, platinum, palladium and a basket of the three, plus gold. The silver, platinum and palladium and basket ETCs have an MER of 50 basis points, reflecting the higher cost of storing the other metals, and no entry or exit fee. As with gold, the platinum and palladium ETCs give the right to own one-tenth of an ounce; the silver ETC covers an ounce.

“We particularly like the basket of silver, platinum, palladium and gold: on the back of silver and palladium lately this has done very well. Or you can buy them as individual metals. We think the ETCs are a good hedge against inflation or as a counter-position to the current volatility of equities, it presents a wide array of opportunities, and of course because those commodities are in demand. It suits short-term as well but also very long-term buy-and-hold based on increased demand for these metals,” says Holzworth.

He also uses stock ETFs, particularly for “more targeted” international exposure. “For example, we’ve been overweight in Singapore, using the iShare ETF over the MSCI Singapore Index (ASX code: ISG). Singapore is on track to record economic growth of 13–15 per cent: everyone is banging on about China having delivered 8–9 per cent, but Singapore shoots it down. We’ve used the ISG to get that exposure, and it costs only 53 basis points.

“We’ve also been overweight in South Korea, using the iShare ETF over the MSCI South Korea Index (ASX code: IKO).  There’s no active managed fund that gives you direct access into Singapore, or South Korea, or Taiwan: there’s no funds that give you that targeted exposure, apart from the iShare ETFs. We’ve been able to build portfolios that have delivered high-double-digits rates of return over the last 12 months, purely through being able to target markets where we see not only market value, but where there’s still underlying growth in the economy,” say Holzworth.

Another example, he says, is the ETF over the S&P/ASX 200 Energy index (ASX code: ENY) offered by Australian Index Investments. “In the short term, if you take the view that the political issues in the Middle East will be protracted, the oil price is going to stay strong, and that’s good for ENY. In the longer term, ENY picks up on themes like gas and uranium. It is a very handy exposure to have, at 43 basis points a year,” says Holzworth.

Paul Oliver, financial planner at the Self-Managed Super Institute, who specialises in self-managed super funds, uses ETFs in a variety of ways. He likes to use healthcare as a defensive investment: for this task he uses the iShares ETF over the S&P Global Healthcare Sector Index Fund (ASX code: IXJ), which seeks to match the total return of the S&P Global Healthcare Sector Index.

IXJ’s top ten holdings are Johnson & Johnson, Pfizer, Novartis, Roche, Merck & Co., Glaxo SmithKline, Sanofi-Aventis, Abbott Laboratories, Astra Zeneca and Bayer. “We like to use the IXJ as a defensive exposure to the giants of the global healthcare industry, which also picks up on the developing world upside, but the prime reason for the exposure is defensive,” says Oliver.

“We also like the GOLDs, we’ve used that quite frequently, during periods of high volatility. It’s a very clean investment, a quick way of getting a hedge on, and it’s backed by gold bullion, there’s no risk. We’ve also started to use the US$ ETF (ASX code: USD) launched recently by BetaShares. I treat that as an alternative asset, because you’re buying it for a specific purpose. You’re buying it if you expect the A$ to fall against the US$, it’s a great way to get exposure to that. It’s a tactical play – it’s not something you would buy and hold – on the basis that at some stage, the A$ has to pull back. If you bought this ETF today at more than 100 US cents, and the A$ dropped back to 80 cents, you would make 20 per cent. We’re looking at that for clients as an alternative exposure.”

Like other ETFs, the USD is cheap, with an annual management cost of 45 basis points. “It’s a great example of the kinds of things that are being brought to market for self-directed investors,” says Oliver. “Instead of setting up a bank account to buy US$ people can do it through one simple trade on the ASX.”

Chris Morcom, director of advisory firm Hewison Private Wealth, also uses ETFs, but likes to augment them with selected active managers. “We have used the iShares ETFs to get exposure to the Asia theme, specifically the iShares MSCI Emerging Markets Index (IEM). We combine that with the iShares S&P Global 100 companies index (IOO). We’ve found that an excellent way to get exposure across a variety of emerging and developed markets, and market-leading stocks. It’s very efficient and cheap exposure: the IOO iShare has an annual cost of 40 basis points, while the IEM is a little bit more expensive, at 69 basis points.

“We also blend in some active managers we believe are worth paying for, in that they actually add value in that global equities class, and we also pick up the emerging markets/Asia theme in those active portfolios. For that purpose we use the Platinum International Fund, the Magellan Global Fund and the Walter Scott Global Equity Fund.”

Because the iShares are denominated in $US and unhedged, Morcom says the rising A$ has hurt ETF investors in the short term. “But there are two things to think of here. Firstly, the A$ will at some point come off, as the US$ recovers, so there is a currency gain likely for Australian investors. Secondly, longer-term, we believe the underlying investments will do very well, and more than make up for any currency effects,” he says.

Andrew Buchan, director of financial planning at HLB Mann Judd, also likes to use ETFs in what he calls an “index/active” approach. “For BRICs and China exposure, we keep that as a part of our international exposure. For that we use an ‘index/active’ approach, where we will use the iShare MSCI EAFE (European, Australasian, and Far Eastern markets) index ETF (ASX code: IVE), and then we’ll use long-short absolute-return fund managers like Platinum or K2 to move us in and out of markets.

You’d be surprised how well retail investors pick up on that strategy. We get the market beta through the ETF, and then we have managers that we believe are better than us at picking when to move us in and out of markets,” says Buchan. “We also use gold ETCs – the GOLDs – as a hedge against inflation.”

Buchan thinks 7 per cent of a portfolio is “about right” for alternative asset exposure. His preferred vehicle is the Macquarie Winton Global Alpha Fund, a long-short managed futures fund that operates in the commodities, index, interest rates and foreign exchange markets.

“The Macquarie Winton fund is a ‘black-box’ global futures fund that has given us very strong returns, plus it has a very low correlation with traditional asset classes, such as Australian shares or international shares. The thing about it, though, is that is not cheap: it’s 2-plus-20 – the 2 per cent management fee and then 20 per cent of any outperformance.

“Nor are the long-short absolute-return fund managers cheap: the Platinums and K2s of the world are going to be at least 2 per cent. We don’t mind that, because you’re asking these people to do some pretty different things, to go short, to pick currency movements – all of that is not cheap. If you’re truly getting alternative exposures and uncorrelated returns, which we think we do, fees aren’t the be-all-and-end-all, because those exposures and returns are worth something,” says Buchan.