A fund ratings agency says investors that use only traditional Australian equity managers are heavily exposed to market risk and are unlikely to benefit from much active management return.
According to van Eyk co-head of research Dr Jerome Lander, an increase in volatility means now is a reasonable time to hedge market risk and allocate more risk to active management.
"Market volatility levels have been relatively low in recent years [and] such conditions have reduced opportunities for active manager returns," Lander said in response to van Eyk's 2007 Australian equities specialist review released yesterday.
"The lack of recent popularity of absolute return hedge fund strategies in Australia has been a result of the very strong returns seemingly available skill free from long-biased Australian equity exposure."
Lander said diversification is now becoming critical for investors.
"While market beta risk has worked well to date, it also exposes investors to large downside risks from falling commodity prices and inadequate portfolio diversification due to sector concentration," he said.
The strong performance of domestic equities merely reflects the limited drivers of the market and large exposures to financials and resources, which have benefited from highly favourable conditions including booming commodity prices, Lander added.
He hosed down suggestions that the stellar run can continue: "The strength of past returns in the last few years cannot be safely extrapolated to the next few years."
The researcher also cautioned investors of Australian equity hedge fund strategies, saying they need to be aware that some managers introduce uncertainties such as heavy exposure to active management risk.
"These strategies are typically heavily exposed to active management risk with key person dependency and boutique business risk being common issues," Lander said.
The researcher also warned investors to ensure they invest with capable and experienced managers who are aligned with their interests.
He said they also need to be satisfied that higher fees can be justified.
