Using alternative assets for diversification

Wednesday 15 December 2004

Traditionally diversified portfolios have been allocated around the following asset classes: of international and domestic equities, international and domestic fixed interest, property and cash.

By The Landlord

However, in recent years fund managers and investors are increasingly looking to add alternative asset classes for further diversification benefits.

There are a number of opportunities available to further diversify a portfolios investment universe. While alternative assets used to be synonymous with hedge funds, in truth there's differing types of property, both global and domestic, CDO's and private equity to name a few. However, the main aim is to add asset classes with a low correlation with the traditional asset classes already used. Correlation is the degree to which the value of different assets move together. For instance, a low correlation between two assets means that when one goes up then the other is less likely to go up in unison, and vice versa.

Property Property has become a part of about half of the diversified portfolios researched by FundSource. Most of these funds have added property to balanced portfolios with a weighting of around 5 per cent, with the remainder having weightings closer to 10 per cent. Those fund managers who have added property to their diversified funds tend to like the stable rental income that property provides plus the additional potential for capital gain. Some fund managers believe that property has tended to have a low correlation with the traditional asset classes which makes it the ideal addition to a diversified portfolio.

Opinions do vary between fund manages however, and other fund managers have analysed long-term property indices and don't believe that the return on property exceeds its rental yield. Further, Kiwis love affair with owning their own home was a factor for them to not include it within their diversified portfolios, on the belief investors of diversified funds want financial assets that are linked to the growth of the economy.

Once fund managers decide to include property they can then choose listed or direct holdings. There are extra costs involved with direct holdings and they?re fairly illiquid whereas listed property securities can be easily sold but the price will be affected by market sentiment. Again the approach taken differs across the funds management industry.

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