Navigating the Search for Returns: Super Funds Explore New Frontiers

Superannuation and insurers are increasingly allocating capital to less traditional assets amid low bond yields.

In a financial landscape marked by historically low bond yields, Australia’s superannuation funds and insurers are exhibiting a notable shift in their investment strategies. This move sees them increasingly allocating capital towards “alternative” investments, a broad category encompassing assets beyond traditional stocks, bonds, and cash. The primary driver behind this strategic pivot is the persistent challenge of generating satisfactory returns in a low-yield environment, a situation that directly impacts the long-term growth prospects for retirement savings and insurance liabilities.

The Shifting Sands of Fixed Income

For decades, government and corporate bonds have served as a cornerstone of conservative investment portfolios, offering a predictable income stream and a degree of capital preservation. However, recent global economic conditions, including sustained low interest rates set by central banks and quantitative easing programs, have significantly compressed the yields available from these traditionally safe assets. This reality means that a portfolio heavily weighted towards bonds may struggle to meet the return expectations necessary for super funds to deliver on their long-term promises to members.

What Are Alternative Investments?

The term “alternative investments” is an umbrella covering a diverse range of assets that typically fall outside the scope of traditional liquid securities. This can include:

• Private Equity: Investments in companies that are not publicly traded on a stock exchange. This can involve buyouts, venture capital, and growth capital.
• Infrastructure: Investments in essential physical assets such as toll roads, airports, energy grids, and telecommunications networks, often with long-term contracts and stable cash flows.
• Real Estate: Direct ownership or investment in property, including commercial buildings, residential complexes, and land.
• Hedge Funds: Pooled investment funds that employ a variety of complex strategies, often aiming to generate returns that are uncorrelated with broader market movements.
• Commodities: Raw materials such as oil, gold, agricultural products, and metals.
• Private Debt: Loans provided to companies or projects outside of traditional banking channels.

These asset classes often share characteristics such as lower liquidity compared to publicly traded stocks and bonds, requiring a longer-term investment horizon. They can also be less transparent and may involve higher fees and more complex structures.

The Rationale: Seeking Enhanced Returns and Diversification

The appeal of alternative investments for institutional investors like super funds lies in their potential to offer higher returns than traditional assets, particularly in the current low-yield environment. Furthermore, many alternative assets are expected to exhibit lower correlation with public equity and bond markets. This diversification benefit could, in theory, reduce overall portfolio volatility and enhance risk-adjusted returns. For superannuation funds, whose members rely on them for retirement income, achieving sustainable growth is paramount. Similarly, insurers must manage their assets to meet future claims obligations, making the search for reliable returns a continuous imperative.

Examining the Trade-offs: Risks and Considerations

While the pursuit of higher returns is understandable, a shift towards alternative assets is not without its considerations and potential risks. These include:

• Liquidity Risk: Many alternative investments are illiquid, meaning they cannot be easily bought or sold quickly without potentially impacting their price. This can tie up capital for extended periods, which may be problematic if a fund faces unexpected redemption requests.
• Valuation Challenges: Unlike publicly traded securities with readily available market prices, the valuation of private assets can be more complex, subjective, and less frequent.
• Due Diligence Burden: Identifying, assessing, and managing investments in private markets often requires specialized expertise and extensive due diligence, which can be costly and time-consuming.
• Complexity and Transparency: The intricate structures and strategies employed in some alternative investments can make them difficult for investors, and indeed regulators, to fully understand and monitor.
• Fees: Alternative investment strategies can often come with higher management and performance fees compared to traditional investments, which can eat into net returns.

While proponents argue that these risks are manageable through careful selection and diversification within the alternative asset class itself, critics often highlight the potential for opacity and the heightened risk of capital loss if underlying assumptions prove incorrect.

What the Data Suggests

Reports from financial news outlets and industry analyses indicate a trend of increasing allocation to these less conventional asset classes by Australian super funds. For instance, research from bodies like the Association of Superannuation Funds of Australia (ASFA) and insights from major financial institutions often detail the growing proportion of assets held in areas like infrastructure and private equity. While specific figures can vary based on reporting periods and methodologies, the direction of travel is clear: a diversification beyond traditional fixed income and equities.

Implications for the Future

This strategic evolution by large institutional investors could have ripple effects across financial markets. Increased demand for alternative assets may drive up their prices, potentially compressing future returns. It also raises questions about market capacity and the ability of these markets to absorb the growing influx of capital without compromising investment quality. For individual investors, understanding how their superannuation is being managed, particularly the increasing allocation to less familiar asset classes, is becoming increasingly important.

Navigating Your Own Investments

For those invested in superannuation, it’s prudent to:

• Review your super fund’s investment strategy: Many funds provide detailed statements of investment strategy or performance reports that outline their asset allocation.
• Understand the risks: Be aware that while alternative assets may offer higher returns, they also carry different risk profiles than traditional investments.
• Consider diversification within your own portfolio: If you manage your own investments outside of super, ensure you have a well-diversified portfolio that aligns with your risk tolerance and financial goals.

Key Takeaways

• Low bond yields are a primary driver for super funds and insurers to seek returns in alternative assets.
• Alternative investments include private equity, infrastructure, real estate, and hedge funds, among others.
• The move aims to enhance returns and diversify portfolios, but carries risks like illiquidity and valuation challenges.
• Careful due diligence and a long-term perspective are crucial when investing in alternative assets.

Looking Ahead

As the search for returns continues in a challenging economic climate, the role of alternative investments in institutional portfolios is likely to remain a key focus. The ability of funds to effectively manage the complexities and risks associated with these asset classes will be critical in ensuring they continue to deliver for their members and policyholders.

References

• The Australian: Super funds, insurers turn to riskier assets for better returns