Our analysis shows that this dominance is the result of two main factors: first, a different attitude to liquidity and, second, a history of smart strategic investment decisions.

Table 1 looks at the performance differential over the past year and over longer periods. In doing so, we need to bear in mind that these are category medians. So, while some industry funds have performed relatively well and some master trusts relatively poorly, there are some where the converse is true.

How do we account for the performance gap, especially over the most recent period? As is so often the case, it comes down not to fees, manager selection or implementation efficiencies, but to strategic asset allocation policies. It is at the ‘big picture’ level that the real differences are to be found.

Table 2 compares the average strategic asset allocations of the three main industry categories at June 2008 while Table 3 gives a breakdown of unlisted assets. Two key factors to note are:

• the different approaches to property investment, with master trusts preferring listed trusts while industry funds have favoured direct investment; and
• the higher exposure of not-for-profit funds to unlisted assets, and especially to the more illiquid assets, unlisted property, infrastructure and private equity.

Table 1: Growth Fund Performance by Segment - Periods ended 30 June 2008 (% pa)
Industry Segment	1 Year	3 Years	5 Years	7 Years
Industry Funds	-5.4	8.1	10.3	7.5
Public Sector Funds	-3.5	8.4	10.7	6.7
Master Trusts	-9.4	6.4	8.9	5.6
Survey Median	-6.9	7.4	9.8	6.5

Note: Growth Funds are those with 61% - 80% in growth assets. Performance is shown net of investment fees and tax.

Table 2: Average Strategic Asset Allocations at 30 June 2008 (%)
Asset Sector	Industry Funds	Public Sector Funds	Master Trusts	Industry Average
Aust Shares	31	31	32	31
Int'l Shares	25	28	27	27
Aust Listed Property	1	1	5	2
Aust Unlisted Property	5	8	1	5
Global Listed Property	1	1	3	2
Growth Alternatives	10	4	5	6
Total Growth	73	73	73	73
Cash	4	3	3	3
Aust Bonds	7	8	11	9
Int'l Bonds	6	11	10	9
Aust Unlisted Property	3	1	0	1
Defensive Alternatives	7	4	3	5
Total Defensive	27	27	27	27
Total	100	100	100	100

‘Alternative assets’ is a convenient umbrella term that encompasses everything outside the traditional realms of shares, property, bonds and cash. But in analysing alternative assets, and their effect on performance, we tend to differentiate on the basis of liquidity. So, for example, hedge funds are classified as alternatives but their underlying investments are predominantly listed securities. So we would classify them as ‘semi-liquid’. Infrastructure and private equity assets, on the other hand, are by their nature highly illiquid.

Liquidity (i.e. the ability to get your money out of an investment at relatively short notice) is a desirable characteristic for most investors. If you are prepared to lock your money up in illiquid assets you would normally expect to receive a premium for doing so. That is what we have witnessed over the past year, and to a dramatic degree.

While listed markets in shares, property, bonds and other credit instruments have been savaged by the US sub-prime mortgage crisis and its worldwide repercussions, illiquid investments have been largely immune. So funds – and here we are talking mostly about industry funds – that have had relatively high weightings to illiquid assets such as direct property, infrastructure and, to a lesser extent, private equity, have enjoyed a substantial performance advantage.

Why have these illiquid, unlisted investments outperformed when the assets they hold are generally comparable to those held in listed vehicles? The main reason is that the professional valuers who appraise the worth of unlisted investments are less aggressive in re-pricing assets – either up or down – than are listed markets.

When it comes to unlisted investments there is no market sentiment, herd mentality, hedge fund activity, short selling or stock lending. Instead, property valuers, for example, look at recent sales of comparable assets (and there have been few recently), the outlook for rental or other income, and the appropriate capitalisation rate to derive a value from that income projection. They are reluctant to take too much account of anything beyond that.

Those valuers are not unaware of listed market activity and what is driving it. They will have observed that, in listed securities markets, risk has been completely re-priced over the course of the past year. That has already caused them to increase capitalisation rates, which most likely will increase further as the credit crisis continues to play out. As a result, we may see further property write-downs over the next six to nine months.

It has been argued that appraisal-based valuations are unrealistic because they are conducted so infrequently. While that may once have been the case, many funds now have timetables that ensure valuations are reasonably current across their portfolios. But few would have re-valued all their unlisted assets at June 2008.

Whatever the arguments, it cannot be denied that holding unlisted investments has been a good decision over the past year at least. Nowhere is that more obvious than in the property sector.

Table 3: Breakdown of Unlisted Assets at 30 June 2008 (%)
Asset Sector	Industry Funds	Public Sector Funds	Master Trusts	Industry Average
Property	8	9	1	6
Infrastructure	6	1	0	3
Private Equity	4	2	1	2
Hedge Funds	7	4	5	5
Total	25	16	7	16

The different approaches to property investment may seem unimportant at first sight, until we come to look at the relative returns of the listed and unlisted sectors of the market, especially over the past year.

The Australian listed property trust index was down 37.7% in the 12 months to 30 June, while over the same period unlisted property returned 14.7%. That is an enormous difference (52%), and it has had a significant effect on overall fund performance (about 3%). Even global diversification was little help for those invested in listed assets, with global listed property (fully hedged) returning -22.5% for the year.

With hindsight, the decision to invest relatively large amounts in unlisted, illiquid assets has been a winner for industry funds.

In recent times some master trusts have started to move in the same direction and have increased their weighting to unlisted assets. These are small steps, however, largely because they and their parent organisations have long memories and unlisted assets pose challenges for funds with daily unit pricing.

Few can forget the pain of the early 1990s when a ‘run’ on unlisted property trusts caused many to freeze redemptions, restructure and seek liquidity by listing on the stock exchange. Reputational risk is a strong motivator, and master trust operators have been conservative about liquidity (maybe too conservative) ever since.

We have commented in previous articles that the advent of choice of fund has elevated the importance of liquidity. Industry funds no longer have captive memberships, so they need to be mindful of the possibility of redemptions, especially if they deliver consistently poor performance. That said, the prospect of a serious ‘run’ on any reputable fund is somewhat remote.

Nonetheless, there are legitimate concerns that some funds are going too far down the unlisted route. How much illiquidity is too much? That is a value judgement for super investors to make. Our view is that a prudent exposure is somewhere between 20% and 30%.

This is partly based on research of large overseas college and university endowments, which have an average allocation to unlisted assets of about 40%. To our mind, as endowments never have to repay the monies gifted (although they do have annual spending requirements), this sets a ceiling on unlisted assets. Super funds can use this example to gauge their own exposure bearing in mind that members can switch funds and change investment options almost at any time.

So far, we have focused on the listed versus unlisted decision and the consequences for fund performance. This is one reason – but not the only reason – why industry funds have performed so well relative to their commercial competitors.

Other reasons for their success include:

• underweighting international shares and overweighting Australian shares and property in the 2002 to 2006 period when the Australian market significantly outperformed;
• reducing equity exposures and building up their cash reserves in the latter stages of the bull market; and
• substituting core infrastructure and absolute return strategies for bonds in the defensive component of their default portfolios to enjoy superior returns while maintaining the same degree of diversification.

Table 4 illustrates the effects of substituting core infrastructure for bonds using the returns from Industry Funds Management’s infrastructure funds as an example.

These decisions reflect well on the funds and on their investment consultants. Whether they indicate a sustainable advantage is a matter of opinion.

The decisions regarding exposures to international shares, equities and cash are more about medium term strategic ‘tilts’ than long term asset allocation. Getting these tilts right consistently is difficult. So it is hard to claim this as a sustainable advantage.

The advantage of investing in alternatives, however, is sustainable if master trusts do not follow suit. But changes are being made, and some master trust portfolios are beginning to look more like those of industry funds.

We have commented before that the master trust offering is not just about returns. They do generally provide a superior member ‘experience’, including personal advice. They also service advisers better, which ultimately benefits members.

It seems an obvious comment, but members really should get independent, professional advice before they switch funds or investments, particularly if their motives are for performance reasons. Importantly, they need to be satisfied that outperformance is likely to continue and that they are taking into account all of the services offered.

Table 4: Performance of Infrastructure vs. Bonds - Periods ended 30 June 2008 (% pa)
	1 Year	3 Years	5 Years
IFM Australian Infrastructure	5.1	8.3	11.6
IFM International Infrastructure	11.8	14.6	n.a.
Australian Bonds	4.4	3.9	4.4
International Bonds (hedged)	7.9	4.9	6.0

Note: Performance for the IFM funds is net of fees and tax. Performance for Australian and international bonds is based on the relevant market indices.