The low (and even negative) interest rate environment brought around by a combination of the residual effects of the Global Financial Crisis and the current COVID-19 pandemic have resulted in SMSFs seeking alternate investment opportunities to maintain their target returns.

Historically, SMSFs gravitate towards either cash and term deposits or listed Australian shares and ignore other asset classes.

In our view the Australian share market might be close to full valuation and continues to be susceptible to pandemic and geopolitical risks. Most SMSF portfolios might be seeking alternatives to equities risk. With interest rates close to zero, cash and term deposits might be limited in compensating for potential losses in listed Australian shares.

So where should SMSFs look to spread the investment risk of their portfolios?

The key is uncorrelated investments - SMSFs can improve their portfolio returns by investing part of their portfolios in assets that are uncorrelated with the rest of the portfolio. An uncorrelated asset is one that responds differently to market forces compared to the rest of the portfolio.

For a SMSF, an uncorrelated asset would generate returns in its own way and does not react to the market forces impacting on, say, Australian equities. Traditionally this role has been played by instruments such as bonds. However, bonds have been shown to be more correlated with equities over short periods, especially where interest rates are at record lows. Moreover, investors in longer-dated bonds might also be subject to capital losses should interest rates rise.

Life settlements are non-correlated to markets

One candidate for the uncorrelated asset might be life settlements. The life settlement asset is structurally non-correlated to the share market, the bond market or property price movements. A well-managed exposure to life settlements can provide potential returns comparable to that of equities over longer time periods, but with less volatility and with no correlation to equities or other investible assets.

To obtain exposure, SMSFs can consider investing in life settlement funds which invest in resold life insurance policies in the United States.  The asset class has been gaining attention worldwide as investors seek uncorrelated returns in a low interest rate environment.

The Laureola Investment Fund is one such professionally managed fund investing in life settlements - it targets total returns of 7-11% p.a. in AUD hedged terms, has assets with excellent credit ratings, and does not depend on the economy to generate returns.

The fund manager distinguishes itself from other life settlement managers by its focus on realised cash returns, rather than accounting valuation gains. A well-managed portfolio of life settlements will keep its diversification characteristics in difficult times. The Laureola Investment Fund has delivered the desired diversification; it makes money uncorrelated to whether other strategies are successful or not. The result is an investment that has no correlation with or dependence upon the usual crisis triggers: declines in share prices, interest rate hikes, economic instability, or geopolitical surprises.

Funds operated by this manager: 

Paragon Australian Long Short Fund