Understanding Asset Classes: Alternative Investments
As the name would suggest, alternative investments are different from mainstream asset classes such as cash, equities and property.
When a SMSF invests in alternatives, it may be seeking to achieve a range of outcomes such as:
- receiving uncorrelated returns, which are returns from asset classes that do not match or correlate to the return profile of mainstream asset classes. In other words, when mainstream asset classes are underperforming, Alternatives may compensate
- investing at an early stage in emerging asset classes to gain a benefit of appreciating asset prices
- investing in collectables
In terms of uncorrelated returns, precious metals such as gold may represent a ‘flight to safety’ solution when financial markets experience ‘shocks’, such economic disruptions leading to downturns in global markets.
In a similar way, if there were to be a disruption in the supply of crude oil, this may flow through to businesses that rely on oil to operate and see their values fall, while the value of oil grows.
By holding appropriate amounts of uncorrelated assets, SMSFs may protect part of the overall portfolio from these types of events. However, exposure to alternative should be considered as part of the overall investment strategy.
Emerging asset classes
An example of opportunity could be seen in emerging technologies and the products that those technologies make possible. Many technologies used today in everyday life started out from an emerging asset class – take mobile communications and data for example.
As a way of considering the relationship between a product and its technology take crypto currencies and the technology they run on – Block chain as an example. Which will be the better investment; investing in the currencies or what could become a more widely used technology, which will be more or less volatile, which will turn into the sustainable asset class of the future?
A further example would be peer-to-peer lending (P2P), which operates outside the traditional banking system to advance loans. What will be the impact on traditional financial services providers, such as banks? So too, with after pay, what does this mean for bank credit cards?
This in itself is not a cohesive asset class as there are so many variations on this theme – artwork, jewellery, antiques, coins, banknotes & stamps and even motor vehicles. The one theme they do have in common is that SMSFs hold these types of assets usually because they are well understood by one or more trustees of the fund. As such, it could be argued that this knowledge will guide good investment decisions.
This is probably true; however, when considering collectables, it is important to refer to the sole purpose test ‘your SMSF needs to be maintained for the sole purpose of providing benefits to members upon retirement or to beneficiaries if a member dies’ and as a result trustees can have no personal use of these assets.
Effectively this means that in the case of a vintage motor vehicle, a trustee cannot drive it or of jewellery, it cannot be worn by a trustee. There are also strict requirements that these items be stored and insured in the name of the SMSF and there are also costs associated with independent valuations.
Alternative assets provide SMSFs with an opportunity to add to a portfolio’s diversification, however by their nature, they are not income assets and are considered to be growth in nature.
Additionally, there may be difficulties if the need arises to sell these assets as there is generally no broad market providing valuations and a buyer may only be willing to pay a price below that of the valuation held by the SMSF.