A new analysis of Australia’s largest superannuation funds has raised questions about the effectiveness of hedge funds to diversify portfolios and manage risk during market downturns.
The study, presented by Frontier Advisors at its annual conference, comes as super funds have approximately doubled their exposure to alternative assets between 2007 and 2016.
“We all like to think that we invest like Warren Buffet but in fact we’ve gone down this allocation to alternatives – and why?” said Frontier Advisors Senior Consultant, Greg Barr.
“It’s quite simple: we’re looking for diversification in portfolios, we’re looking for a better way to manage downside risk. So the alternative exposure is the great ‘magic pudding’ to deliver growth-like returns, lower risk and low or negative correlation to equities.”
Funds with higher alternative asset allocations posted marginally improved crediting rates over the financial year to date as traditional markets have struggled. However, that result was reversed – higher alternative allocations actually dragged down crediting rates – when infrastructure and private equity were stripped out of the alternatives universe.
“The other assets within alternatives in terms of hedge funds, absolute return funds and the very well named ‘miscellaneous alternatives’ and ‘alternatives other’, haven’t actually delivered on that premise of low to negative correlation to equities.”
Barr said similar poor results were found over 10 years but this shouldn’t be seen as a reason to rule out all hedge funds.
“The ‘magic pudding’ of having higher returns, lower risk and low correlation to equity markets is very hard to find and hard to achieve. So we look at alternatives in a different way – we divide up alternatives to look at the actual characteristics you’re investing in – those that are return-seeking, those that are true diversifiers, or opportunistic investments.”
Barr also referenced Warren Buffet and hedge fund, Protégé Partners, famous wager pitting the net performance of the S&P500 (via a Vanguard Index Fund) against a portfolio of five fund-of-hedge funds over the decade beginning in 2008. By the end of 2015, the S&P500 was well ahead with a 65.7 per cent return against Protégé’s 21.9 per cent.
A number of major funds have also withdrawn support for the sector in recent times. In April, the $US51 billion New York City Employee Retirement System (NYCERS) voted to exit its $US1.5 billion portfolio of hedge funds and, in September 2014, California’s Public Employees’ Retirement System divested its $US4 billion hedge fund portfolio. Both funds cited issues with performance and excessive fees.
View the session slides here.
